Prior to the Legal Entity Identifier (LEI) there has been no readily available way of identifying an entity (typically a corporation or some other entity which can take on financial counterparty risk) in a unique and clear manner. Most countries have one or several Trade or Business Registries where entities can obtain a local registry number. However, for cross-jurisdictional purposes these local registry numbers have been hard to implement in a uniform way.
As part of an international agreement on the need for further financial reform and regulation of the financial industry, in 2009 the G20 countries committed to reform the global OTC derivatives markets. This commitment has lead to local legislation being enacted in the US and the European Union that makes the use of LEI obligatory for any party to a derivative contract. Also as of 3 January 2018 any corporation or entity buying or selling a financial instrument admitted for trading will need an LEI to comply with MiFID II/MiFIR in the EU.
The implementation of the LEI will play an important part in this drive for more transparency on financial counterparty risk since it will mean that the same legal entity can be uniquely identified in all regulatory transaction reporting.
Impact of European Market Infrastructure Regulation (EMIR)
All entities established in the European Union must comply with the rules and practices of EMIR. As regards LEI the most relevant section of EMIR is the Reporting Obligation.
The Reporting Obligation stipulates that both parties to a derivative contract should report such activity to a so-called Trade Repository. To make this possible the reporting party (or the party to which it delegates the reporting) must identify the party to a derivative contract using an LEI.
The Reporting Obligation of EMIR started 12 February 2014 for all counterparties to derivatives contracts. Using an LEI to uniquely identify legal entities became compulsory at the same date, which has led to this being part of normal Know-Your-Customer (KYC) routines for banks as an onboarding criterion.
For the interested reader the EU Regulation is available in all EU official languages at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32012R0648:EN:NOT. For a detailed specification on what entities are regulated by EMIR see Article 2 (Definitions) paragraphs 7 and 8.
Impact of Markets in finaicial Instruments Direct II (MiFID II/MiFIR)
From 3 January 2018 the Transaction Reporting that investment firms and credit institutions are obligated to perform to competent authorities (regulators) in the EU area will be extended. Among other things, identifying legal entities using LEI will become mandatory. It is foreseen that additional bank customers will be affected in addition to the ones already having obtained an LEI due to EMIR.
For the interested reader more information about MiFID II is available at http://www.esma.europa.eu/page/Markets-Financial-Instruments-Directive-MiFID-II.