How LEIs Are Reshaping Finance
Published: September 28, 2022
A legal entity identifier (LEI) is a simple tool that can help companies build trust in new relationships. This can be especially useful for trade in and out of emerging markets. With LEIs now becoming digital, new opportunities are arising, says Benjamin Würzburger, Chief Operating Officer of TMI Innovation Lab entry, Ceviant.
An LEI is effectively a barcode giving more insight into a company’s financial transactions and any risks a counterparty might be exposed to in dealing with it. It works in a similar way that a Social Security number does for an individual in the US. Just as this can be used to track everything that individual has done, each loan they have taken out, how much money they have saved, their spending habits and so forth, so an LEI tracks this data for companies, but on an international level.
As a compliance officer, when I receive a company’s LEI, it enables me to check that company’s financial history, no matter where it is based, whether it is in the Middle East or Australia. It helps eliminate data duplications for both clients and financial institutions.
The LEI is part of a globally standardised system which was created in the wake of the 2008 financial crisis. When regulators became acutely aware of the dangers of not being able to identify parties to transactions across markets, the Financial Stability Board (FSB), along with G20 central bank governors and finance ministers, pushed for a universal system to be implemented. This ultimately led to the development of the Global LEI System (GLEIS) and the establishment of the Global Legal Entity Identifier Foundation (GLEIF). GLEIF supports the implementation and use of the GLEIS, certifying and managing a network of LEI issuing organisations – Local Operating Units (LOUs) – that register and renew companies’ LEIs.
Every LEI is a unique 20-character code, which can be assigned to any legal entity involved in financial transactions, such as companies, banks, insurers, or investment funds. When registering for an LEI, the company provides the standard information that it would for any due diligence check, such as its financial transactions, banking history, location, and directors. Once the LOU has been provided with all this information, the business is registered on a platform that anyone can access to verify the identity of the business and gain more insight into it.
Additional use cases
Within capital markets, LEIs are useful for reducing the costs associated with onboarding clients and the cost of processing of stocks, bonds, and other securities trades. All these processes could be simplified and streamlined if LEI usage were more widely adopted throughout the life cycle of the client relationship. Broader use of LEIs would also reduce the time spent on data correction and reconciliation, which are both time-intensive processes for treasury managers.
In commercial transactions, LEIs enable faster processing of LCs, and better identification of sellers on e-invoicing networks. In the life cycle of commercial transactions – especially international transactions – several manual, time-consuming activities are required to complete the transaction. Verifying the identities of counterparties is especially laborious and often includes a considerable amount of manual processing. With the help of LEIs however, identity verification can be automated, enabling many of the activities required in the invoicing and trade finance steps of a commercial transaction to be digitised.
Extending commercial credit also becomes much simpler with LEIs. When extending credit to commercial borrowers, a lender has to ascertain the borrower’s identity, history, ownership and group structure. This can be incredibly complicated as small businesses often include multiple entities with similar names. However, if such entities all had LEIs, this would significantly simplify the KYC due diligence on borrowers, as well as enabling better traceability of information on borrowers from multiple sources.
Now trending
LEIs are being rapidly adopted in the Middle East and Africa. In more developed markets, it is easy to use third-party software or specialised search engines that are geared towards finding out a company's risk level and financial history. However, conducting such checks on companies in the Middle East and Africa is far more difficult.
As companies from developed markets are conducting more business with organisations from developed markets, they need to be able to verify details about the latter. The LEI is therefore an essential tool for bridging the compliance difficulties of working with companies in emerging markets, and this trend is likely to continue.
Regulators in many countries are strongly recommending LEIs. For example, LEIs are now a legal requirement for all companies seeking to trade on financial markets within the UK and EU. GLEIF is also pioneering a digital version of the LEI, known as Verifiable LEI (vLEI). These can eliminate the need for human intervention, can be verified in a decentralised manner, and can be used to gain more insight into cryptocurrency transactions.
As we move towards a more digital economy, the number of businesses that regularly need to move funds around the world will only increase. LEIs and vLEIs may well become essential to the future of international companies.