Stephan Wolf, CEO, GLEIF
In today’s digitally-driven world, we are used to having information at the touch of a button. But, when it comes to legal entity identification, we seem to be stuck in the past, using manual processes that could be greatly improved upon.
To fully understand the extent of the problem, and the solution that can not only help firms to meet regulatory needs but even create business value, we first need to look at why current entity verification methods are not enough.
Why current entity verification processes are not fit for purpose
The identification and verification procedures used today have a significant number of manual components and often require the use of multiple databases. Adding to this, counterparties may be identified by different names as many banks and corporations still use names rather than identifiers.To illustrate the issue, a large bank’s client services division recently found that one organisation had an average of five names, with minor variations, in its database.
Another example of current inefficiencies is in know-your-customer (KYC) processes, where firms work to verify their clients’ identity by conducting robust due diligence. The lack of consistency and clarity within these processes means that banks spend considerable time and resources on what should be a simple task.
But it doesn’t have to be that way.
Legal Entity Identifiers – creating greater transparency in financial markets
Created in the wake of the 2008 financial crisis, the Global Legal Entity Identifier (LEI)System helps to solve these issues by assigning unique identifiers to legally distinct entities, allowing for the quick identification of counterparties participating in financial transactions.
The LEI is a 20-digit alpha-numeric code based on the ISO 17442 standard developed by the International Organization for Standardization (ISO). It connects to key reference information that enables clear and unique identification of legal entities participating in financial transactions. The Global Legal Entity Identifier Foundation (GLEIF) makes available theGlobal LEI Index, which is the only global online source that provides open, standardised and high-quality legal entity reference data.Each LEI contains information about an entity’s ownership structure and thus answers the questions of ‘who is who’ and ‘who owns whom’ among market participants.
Simply put, the publicly available LEI data pool can be viewed as a global directory, which greatly enhances transparency in the global marketplace.
There have been a range of regulatory initiatives in Europe and the US that have helped encourage participants to adopt unique, cross-industry LEIs. However, the use cases for LEIs go beyond compliance needs, and apply across different aspects of an organisation to create real business value.
LEIs – business value beyond compliance
A recent white paper released by McKinsey & Company and GLEIF titled ‘The Legal Entity Identifier: The Value of the Unique Counterparty ID’ finds that broader, global LEI adoption can add further value to businesses in two main ways. Firstly, it can take some of the transactional and operational friction out ofthe identification of transaction counterparties. Secondly, it can make important information about the background of a legal entity in a specific transaction easier to accessand trace.
When combined, these benefits do not just help organisations reduce the amount of time spent on identifying counterparties, but also improve the reliability of the information. Additionally, there are further ways in which the LEI can create business value. Examples of these can be seen in, but are not limited to,a number of use cases in capital markets, commercial transactions and the extension of commercial credit.
Capital markets: additional revenue with LEIs
Market participants involved in over-the-counter (OTC) derivative trading were the first to widely adopt and use LEIs, a move that was spurred on by regulation.But, once they had obtained LEIs, banks increasingly discovered their value beyond being able to instantly identify counterparties in OTC derivatives transactions.
In fact, a number of investment banks are now using the LEI during the trading phase of the client relationship to reconcile information about their clients’ positions, both within the bank and also externally with their clients.
Further benefits have also been noticed when it comes to onboarding clients and middle- and back-office activities,where the use of LEIs can help to considerably reduce the time and resources needed to attribute the right information to the client they want to onboard.
McKinsey estimates that the use of LEIs in capital markets could lead to a 3.5% reduction in the overall capital markets operations costs. For the global investment banking industry alone, this could result in over $150 million in annual savings. But the benefits don’t stop there – banks can also gain additional revenue by shortening the ‘time to market’ for trading with customers, while simultaneously improving the client experience with the adoption of LEIs.
Commercial transactions: automating identity verification
In order to complete commercial transactions – especially internationally – there are several manual, time-consuming activities that have to be done.
This challenge is clearly illustrated in the application most relevant to LEIs, where buyers obtain letters of credit or bills of exchange from their banks to facilitate payments to sellers, and sellers use purchase orders or invoices to get financing for production and purchase. This is a very lengthy process which typically involves multiple steps.
The use of LEIs could not only automate identity verificationas part of this process, but also help to defend against fraud risk by tracing outstanding invoices, and multiple invoices for the same shipment, to identify suspicious activity.
On an annual basis, banks could collectively save between $250 million to $500 million if LEIs were used not justto identify international entities,but to automate the tracing of their history for the issuance of letters of credit.
Commercial credit: standardising systems
When it comes to extending credit to commercial borrowers, which happens in four broad phases – origination, underwriting, administration, and portfolio management – a lender needs to establish the borrowing entity’s identity, history and ownership group structure. This is a complex and lengthy process that requires multiple internal and external databases.
What’s more, entities often apply for multiple loans at various times, making it even more important to have clear traceability and reconciliation across different systems, data sources and business units.
The use of LEIs when extending credit to commercial borrowers can not just facilitate the standardisation of the process and lessen the time spent on verifying each entity, but accelerate the necessary anti-money-laundering (AML) and compliance checks during the administration phase.
This then helps to free up working hours spent on manual processes, which can then be used towards creating the potential for new revenue streams.
The business value that can be derived from adopting an LEI is not limited to those examples mentioned here. Introducing the LEI into almost any process with a manual component that requires counterparty identification and verification can result in more reliable information, operational efficiencies, cost savings and a reduction in time it takes to onboard clients. These benefits will only grow as more companies and banks work together to encourage the adoption of the LEI.So in order to reap these benefits, as well as the potential for further automation and digitisation of financial and commercial transactions, every business should adopt an LEI.