EU trading venues warn over looming end of LEI relief

Expelling issuers with no legal entity identifiers could hurt liquidity and investor strategies

Speeding towards the deadline: despite extra time offered by Esma to obtain identifiers, some issuers still lack them

European trading venues are sounding the alarm over the consequences of potentially having to delist certain securities because their issuers still do not have a legal entity identifier (LEI), once a six-month relaxation in LEI rules expires on July 2.

The consequences could include lower liquidity in those securities, a return to over-the-counter trading, migration of some business to countries outside of the European Union and an impact on investors’ strategies.

The LEI requirements were brought in by the second Markets in Financial Instruments Directive (Mifid II) and its accompanying regulation Mifir. Mifid II obliges EU platforms to report to regulators the LEIs of the issuers of all financial instruments they make available for trading. The law means that, if an issuer does not have an LEI, the venue must delist the issuer’s security.

This requirement could now come into conflict with one of the objectives of Mifid II: to encourage trading to move away from bilateral deals and onto regulated markets, such as multilateral trading facilities and organised trading facilities.

“It could drive business back to the phone or outside of the EU, which seems to run contrary to Mifid II,” says a regulatory expert at an EU trading venue.

The six-month relaxation of the LEI requirements was granted by the European Securities and Markets Authority in December as concerns mounted that not all issuers and clients of EU investment firms, which are also in scope, would have LEIs before Mifid II came into force in January. Esma allowed venues to use their own LEI where an issuer does not have one – but only for issuers outside of the EU. It also allowed investment firms to delay, under certain conditions, the reporting of transactions involving a client who does not yet have an LEI.

Despite the extra time to obtain the identifiers, some issuers still lack them.

For Esma chairman Steven Maijoor, their number is too small to be concerning. In a speech on June 21, he suggested that enough entities had now obtained LEIs for there to be no need to extend the grace period.   

“Currently 95.5% of the instruments reported in our reference data system have the correct [rather than substitute] LEI. This positive development led to the confirmation of the end of the six-month period,” he said.

This broadly tallies with figures supplied by Trax, a service for releasing to the public and to regulators the details of transactions: 2.6% of bonds reported through it do not have issuer LEIs.

If the bond is not available on a [EU] trading venue, the secondary market liquidity would be much lower

Regulatory expert at an EU trading venue

Others are more worried.

“We trade global bonds on fixed-income platforms including EU platforms, and the number of issuers that are still on those platforms without an LEI could still be a problem,” said Andrew Bowley of Nomura, whose role includes overseeing the development of the bank’s global markets business in response to new regulation. He was speaking at a conference on June 11.

He did not elaborate but trading venues point to a number of problems with taking instruments off European platforms.    

“Secondary-market liquidity matters a lot to any investor in the primary markets because at some point they might have to sell that bond,” says the regulatory expert at the EU venue. “Clearly if the bond is not available on a [EU] trading venue, the secondary market liquidity would be much lower.”

If a security is removed, the only way to trade it will be either on a venue outside the EU or OTC. The latter in particular would go against “one of the big objectives of Mifid II” of bringing more trading onto regulated entities, the expert adds.

The ability of investors to implement certain strategies could also be affected.

“The impact of removal of certain bonds … from EU trading venues could lock EU investors into [trading] positions without access to their normal trading venues,” says Jason Waight, head of regulatory affairs at MarketAxess, an electronic fixed-income trading venue.

“This could have detrimental effect upon EU investors who are required to track an index… If those investors are unable to trade those bonds on a [EU] venue, it could drive up the cost of replicating the index and create [negative] tracking errors, amongst other risks detrimental to the EU investor.”

In this scenario, in order to replicate the index – as their mandate states – the investors would have to go to a non-EU venue to trade one of the component securities. As they may not have an existing relationship with the platform, there would be set-up costs, which would then eat into the performance of the fund that is meant to track the index and may cause it to undershoot. Such deviation is known as tracking error.  

The [LEI] obligation cannot be waived

Spokesperson, European Securities and Markets Authority

A June 20 statement by Esma sparked hopes in the market that the authority might give national regulators, or NCAs, the leeway not to enforce the LEI requirements after the relief period expired.

“Esma and NCAs are coordinating the development of an appropriate and proportionate common supervisory action plan focused on compliance with the LEI reporting requirements,” Esma said. “When applying this approach in practice, NCAs will need to consider the severity and the particular circumstances of individual infringements. In doing so, NCAs should respect the proportionality principle and also consider the impact on investors, market functioning and integrity.”

However, a spokesperson for Esma clarifies: “The obligation cannot be waived… This statement means that the severity and the particular circumstances of the infringement will need to be considered by the relevant national supervisor when choosing the necessary supervisory measure to be taken to address the specific case of non-compliance.”

The spokesperson adds that the requirements apply irrespective of whether a common supervisory action plan is in place or not.

Unlike investment firms which are well-placed to persuade their clients to obtain an LEI, trading venues have no existing relationship with the issuers of the securities they list. When they do contact the issuers, they run into particular difficulties with those outside of Europe. Sometimes the problem is as basic as not speaking the same language.

Many issuers without an LEI are based in East Asia – for example, the governments of Malaysia and Thailand are not listed in the database of the Global LEI Foundation, which is the official golden source for LEI data.

Editing by Olesya Dmitracova