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Advisers face Mifid legal code conundrum

Incoming EU regulations may require advisers and clients alike to obtain a so-called ‘legal entity identifier’ code to carry out transactions.

Advisers face Mifid legal code conundrum

It would be fair to assume most advisers are not experts on legal entity identifiers (LEIs). After all, the unique number system originally only seemed to be necessary to companies and individuals who worked across borders around the world.

LEIs were established by the G20 international forum in 2012 to ensure financial transactions taking place across international borders could be traced. Large financial companies such as banks, for example, require an LEI code to make money transfers across borders. 

Why should advisers care then? The answer is in the EU’s Mifid II regulations, which come into force in January 2018.

Under this legislation, LEIs will be used to identify market abuse in financial trades. This means that some institutions, companies and trusts will need to obtain an LEI to complete transactions.

The problem facing advisers is that, at the moment, it is far from clear who exactly needs to have an LEI, and who is responsible for obtaining one. 

Who needs an LEI?

According to Robert Taylor, consulting director at compliance specialists TCC, both the client and the firm making decisions on their behalf could be considered a legal entity under the Mifid II rules.

He presented the example of having an individual client whose affairs and investment decisions into reportable financial instruments are dealt with by a power of attorney (POA). The POA is exercised by a legal entity, usually a firm of solicitors. As the solicitor is considered a decision maker, they would need to obtain an LEI.

Taylor said: ‘In this example, the individual/client should have either a national insurance number or relevant identification number, if a foreign national. This should form part of the transaction report.

‘As the POA is a legal entity, an LEI should also be reported as part of the transaction reporting, as a “decision maker” is in place.’

Further complications could be added if the client with POA invests through a discretionary fund manager (DFM).

‘You have a legal entity as a client and, based on your recommendation, they invest into a discretionary management arrangement, which invests in reportable financial instruments. The DFM makes decisions on behalf of the client (i.e. which reportable financial instruments to invest in and in what proportion). So they would be considered a decision maker, and therefore both the legal entity client and the DFM would require an LEI.

‘In this example the legal entity is a client and therefore, due to the investments made, [the clients] should have an LEI. As the client’s investments are made into a discretionary portfolio, the discretionary manager will also need an LEI as they are making decisions on the client’s investments.’

Planning ahead

This could create a headache for advisers with clients that are legal entities or have POA, and which invest in any of the listed financial instruments. Advisers would not be able to carry out transactions on their behalf in those instruments once the Mifid II rules come into force. This is unless the client has obtained an LEI or the adviser has done so on their behalf.

Vince Harvey, director of compliance specialists Compliance Cubed, said some firms have begun telling clients they need to purchase LEIs. But he added one of his clients had begun obtaining them on behalf of their clients.

‘Most firms are dealing with private individuals and, as such, do not need to worry about it for those cases,’ he said. ‘But a firm I deal with is looking at 12 to 15 clients that are legal entities. So it is worth getting those sorted in good time for the peace of mind. Advisers don’t want trades being blocked by a platform because the client has neglected it.’

Understanding the LEI requirement is key for some advisers, according to Phil Young (pictured above), director of Zero Support. He said: ‘Strictly speaking, all DFMs need one and anyone advising on exchange-tradable products. This includes exchange-traded funds [ETFs], shares, investment trusts, corporate bonds, gilts, venture capital trusts and structured products.

‘Most platforms seem to be holding to that line but warning advisers they can’t place a trade unless they have one. They can take a week or more to get, so it might be a good idea to get one now. I know two platforms that are insisting all advisers using them get one. This is their prerogative but beyond the rule.’

Indeed, a senior source in the platform market told New Model Adviser®: ‘If we get a trade where there is a reportable asset and no LEI, we will block the individual trade and inform the adviser. Clients invest in a number of assets at once, not normally a single asset.

‘However, if we get a trade into a model portfolio, where the majority of our business is traded, the whole trade will be blocked as you can’t be linked to a part-model. If there is market movement and the trade doesn’t go through, there could be claims for compensation. This could be very expensive.’

Whose responsibility is it?

There are conflicting views as to which party should secure the LEI.

Graham Bentley, managing director of investment consultancy GBI2, said: ‘Suppose you are an adviser buying and selling products on a platform. My interpretation, supported by some platform providers, including Old Mutual Wealth, is that it is the responsibility of the platform to get the LEI. After all, they are doing the trading.

‘But they don’t deal with investment trusts or equities, so they are not dealing with items on an exchange anyway. This is not the case with a platform like Transact or FundsNetwork, where advisers are allowed to trade in ETFs and equities.

‘For advisers on these kinds of platforms, they will need to ask whether that organisation will be the physical owner of the underlying investment, as that is what counts. In that case, they will need an LEI and the adviser will not.’

Bentley suggested that, although many advisers are likely to be in the clear, it would be worth revisiting both the client bank and platform arrangements.

He said: ‘The idea of an identifier making sure parties to a transaction can be identified will not matter in most cases as clients are identifiable already. If buying an ISA, for instance, the record is already there in the form of an NI number, so ISAs are not included. Collective investments are not included. It doesn’t apply to pension schemes and investment bonds as they are not Mifid II products.

‘The people who have the most to contend with are DFMs who deal with equities. Advisers, however, will need to look through their client bank and make sure they can identify and contact any clients who are corporates, trusts, and charities.’ 

Navigating the chaos

The potential kerfuffle associated with LEIs was flagged up in May by Gareth James, head of technical resources at AJ Bell. In an article for AJ Bell’s InvestCentre, he assigned them ‘the award given to under-the-radar rules that are likely to bite the unprepared’.

With platforms taking different lines and the Mifid II implementation date closing in, advisers will need to start looking at both their client bank and platform provider for guidance.

Mark Polson (pictured above), principal of consultants The Lang Cat, said the best plan for advisers was to get hold of an LEI now to cover their backs. To do this, advisers must visit the London Stock Exchange website, where they can buy an LEI for £117.

He said: ‘There are so many shades of grey in terms of how the UK deals with this stuff, that if I was a firm, I would just go and get an LEI. It is not a big expense, and with so much ambiguity, it is better to know that side of things is covered.

‘If someone comes along at a later date and says you’ve gone about it the wrong way, it is less of an issue than if it turned out you didn’t have one and should have.

‘For the cost of a nice dinner out, you get some crucial peace of mind. It will stick in the craw of many firms that don’t use exchange-traded assets, but it is best to look at it like car insurance. You might not consider yourself capable of having an accident, but you get the insurance anyway.’

There is much confusion around the full scope of the Mifid II rules. This common sense tip is the only way advisers can be certain of complying with the rules when they come into force next year. 

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