(September 2022)
By Stephen Ptohopoulos ACIB CDCSAdv CITF CSDG CSCF QTFS*
Disclaimer: Views and opinions expressed are those of the author and are not necessarily those of his employer.
The Legal Entity Identifier (LEI) – facilitating KYC, trade finance and much more
(September 2022)
By Stephen Ptohopoulos ACIB CDCSAdv CITF CSDG CSCF QTFS*
Disclaimer: Views and opinions expressed are those of the author and are not necessarily those of his employer.
In this article I will give an overview of the Legal Entity Identifier (LEI); what it is, its features, functions and use cases. The way I see this technology is inevitably shaped by the fact I am a trade finance professional. Therefore, many of the observations and examples are drawn from the world of traditional trade finance (TTF) and supply chain finance (SCF). Hereafter, all mentions of ‘trade finance’ is to be construed as meaning TTF and/or SCF.
Globalization has resulted in the growth of cross-border finance, investments and trade transactions. One of the challenges that can stand in the way of successfully realising such opportunities is establishing trust through the ability of counterparties to accurately identify each other. Often it is difficult to access accurate, timely and reliable information about a prospective foreign counterparty.
In a domestic context, counterparties may already know each other and/or rely on informal, local intelligence (soft ‘proprietary’ information). In a cross-border context, codified data (hard information) is often required. Legal entity data, such as incorporation particulars, registered address, list of the main owners (shareholders) is used to identify a counterparty. This data is typically held in a database (repository) operated by a private entity or a public authority (example of the latter being a companies’ registrar). Issues for the enquiring party might include:
- Having to communicate with an entity/authority that maintains the data repository located in a foreign country
- Language barriers: Correspondence and/or requested data is in a foreign language
- Time taken between applying and receiving the requested information (hours, days or weeks)
- Data content and data format
- Information might not be up to date
- Data quality issues. Has the data been audited? Veracity of the data?
- Information is not provided free of charge (e.g., there may be a paywall)
This is the context in which LEI came about. The LEI seeks to address the above ‘pain points.’ The idea being that data of multiple legal entities, incorporated in different jurisdictions/countries can be accessible from a sole authoritative source instead of from a patchwork of domestic databases / repositories.
A legal entity can be assigned a unique global ID: the LEI – which is a 20-character alphanumeric code (based on ISO 17442). To use an example from the world of trade finance, Maersk A/S, a container vessels operator is: 254900BLYIXBFFRLUJ90. To find the LEI of a legal entity you simply need to make a search on the GLEIF website: www.gleif.org.
To date over two million LEIs have been issued, for legal entities from countries in all continents. Most being multinational corporations (MNCs) and mid-market companies (MMCs) in developed countries, with many listed on domestic stock exchanges and accounting for most of the world’s market capitalisation. By implication, few LEIs have been issued for micro and medium sized enterprises (MSMEs) and few are from developing countries – this matches the profile of the very businesses that are typically least able to access trade finance, in what has been termed the ‘trade finance gap’².
²A study by the Asian Development Bank (ADB) – which is multilateral organisation – estimated the trade finance gap to be to the tune of USD 1,5 trillion
The LEI is a free to use global corporate database (i.e., it is a public utility). Being both open source and open data ensures transparency. It also means in more practical terms that searching for an LEI is as easy as a Google search and the data is downloadable, so that for example it can be imported into a businesses’ own database. The LEI also provides an application programming interface (API) (the GLEIF API) which gives software developers access to its LEI data search functionality.
The LEI goes a long way towards answering the key questions of ‘who is who’ and ‘who owns whom.’ As alluded to previously, the LEIs are stored on a type of database. While the LEI on its own represents raw data with no meaning it is linked to reference data about the legal entity. Each LEI record has two components (levels):
Level 1 – what is described as ‘business card information’: the legal entity’s full / official name and registered address. Thus, it addresses the ‘who is who’ question.
Level 2 – relationship information: the legal entity’s direct and ultimate owners. Thus, it addresses the ‘who owns whom’ question.
It should be noted that each record also links the LEI to unique industry identifiers. If the legal entity is a direct participant in the SWIFT payments network its BIC is recorded³ and if it has issued financial (debt) instruments / securities, the relevant ISINs will be recorded. This has obvious benefits in terms of data portability and interoperability.
³Remembering that membership of SWIFT is not confined to banks and other types of financial intermediaries but also to non-financial corporate customers
The issuance of LEIs to legal entities is sub-contracted to external parties called Local Operating Units (or LOUs for short). LOUs, more commonly referred to as LEI issuers are accredited by GLEIF. The process of obtaining an LEI is as follows:
1.The LEI applicant submits data (self-registration)
2.An LEI issuer verifies the data though a local/national authoritative source such as a companies’ registrar
3.LEI is issued and published
This infrastructure and federated network of LOUs is managed by the Global Legal Entity Identifier Foundation (GLEIF). Founded in 2014 by the Financial Stability Board (FSB), GLEIF is a supranational not-for-profit organisation. GLEIF is overseen by the Regulatory Oversight Committee (ROC) – the latter being a group of sixty-five regulatory authorities from around the world.
The LEI is a digital identity that has been designed to be ‘fit for purpose’ for the digital economy. The verifiable LEI (vLEI) – which is the digital version of the LEI – makes LEIs digitally verifiable, enabling the identification of legal entities involved in digital transactions. This is machine readable data and so supports seamless digital workflows doing away with manual, human interventions and resulting in more efficient processing and increased productivity. The data components of the vLEI are i) the legal entity (represented in the form the LEI), ii) name of natural person who represents or engages with the legal entity, and iii) the function or role of the named natural person (e.g., CEO). Therefore, the recipient of a digital record can verify by digital means who they are transacting with, who is acting on behalf of the legal entity, their role and by implication that this person is an authorised to do so. These digital products and solutions have been designed by GLEIF to be interoperable, thus the ability potentially to connect to any network, distributed ledger technology (DLT) or blockchain.
The LEI is ‘digitally signed’ by the owner, generating a hash. This digital signature can then be incorporated in data or e-documents used in a trade finance transaction. A ‘zero trust’ method of authentication can be used, whereby the addressee / recipient does not require an intermediary to perform the function of authenticating the data or e-documents. A significant benefit is a reduction in fraud.
As mentioned previously, the vLEI can record that it has been digitally signed by a natural person authorised by the legal entity, acting in a designated function, role or capacity. This means that the vLEI can address the typical question of ‘who signed what?’ A good example that has been sighted to demonstrate its practical use is the filing of audited financial accounts. This document can now be issued in the Expandable Business Reporting Language (XPRL) format. An XPRL document superficially resembles a standard PDF file. However, a closer inspection reveals that the XPRL document has additional features. For example, by scrolling on an individual item / figure on the balance sheet, profit and loss or cash flow statement will display who – person’s name and role/capacity (e.g., the CFO) – signed off that data. It should be noted, as alluded to previously, that aside from authorised company officials like the CEO, Secretary, CFO, etc., documents issued by a legal entity may be digitally signed by an associate / external third party. So, in the case of audited financial statements, the external auditors will digitally sign certain data. If finance providers have an easy, efficient means access financial data in a timely manner that can be trusted, this should enhance their capacity to make credit decisions and accept new business.
In a trade finance context, the vLEI can be used to digitally sign documents (records) or data associated with the legal entity. Therefore, it can be applied to data or to electronic records (e-records) typically used in trade finance transactions. Examples of such e-records include the electronic commercial invoice (e-invoice), electronic bill of lading (eBL), electronic air waybill (eAWB) and the electronic certificate of origin (eCO). Note that an e-record or data incorporating a vLEI which is digitally signed will automatically be construed to be an electronic signature, as defined by the International Chamber of Commerce (ICC) contractual Rules governing trade finance transactions involving the processing of e-records (eUCP and eURC) and data (URBPO and URDTT), since a key feature of these Rules is that they are technologically agnostic⁴
⁴A more detailed coverage of the digitisation of trade finance was explored in a previous article I wrote, titled: Efforts and initiatives relating to the digitisation of international trade finance (February 2021)
It has been pointed out that to realise the full potential benefits of the LEI we need to find ways to ensure that LEIs are issued to more MSMEs. This could be a game changer, in terms of financial inclusion, enabling MSMEs, particularly in developing countries, to participate in international trade and obtain access to trade finance (thus boosting economic development). Stephan Wolf, CEO of GLEIF opines that an LEI adoption rate of 70-80% for MSMEs would be a ‘tipping point’, meaning that even in the absence of the imposition of mandatory regulatory requirements the momentum generated would induce the remainders to obtain an LEI. I think it would be useful to mention at this point that there is no reason a traditional bank could not leverage its existing resources and capabilities, not least in terms of knowing its customers and customer data, to be an LEI verification agent. After all (to paraphrase Stephan Wolf) a bank’s involvement in the issuance of LEIs for its clients flows naturally from and is a byproduct of its internal KYC, CDD and onboarding processes. This could represent not just a cross-selling opportunity but also an additional income stream for the banks. Furthermore, as a form of non-interest income (and yet another example as we move into the digital age) of how banks can diversify their sources of profitability and thus reduce their dependence the interest spread business. Indeed, there are real life examples of banks that issue LEIs for their clients.
The final part of this article focuses on use cases. As Stephan Wolf points out, the application of LEIs is not confined to financial transactions. The below list of examples is by no means exhaustive.
A good example cited by Stephan Wolf which is topical and that we can all relate to concerns the fight against COVID-19. The pharmaceutical industry developed a blockchain representing the supply chain, from the suppliers of the raw materials used to develop the vaccines (upstream), the vaccine manufacturers / pharmaceutical companies, channel intermediaries / distributors to the pharmacies at the point of delivery (downstream). This blockchain was underpinned by the digital version of the LEI, ensuring greater transparency since all participants in the supply chain were required to a have a vLEI.
The customs regulations in certain countries (e.g., The People’s Republic of China) have made it a mandatory requirement for exporters* (*that meet certain criteria) to provide their LEI on customs declarations submitted to the importing country’s authorities.
Regulators are phasing in requirements calling for counterparty LEI data to be mandatory on payments processed by their domestic financial systems.
LEIs can be used in the fight to combat duplicate financing fraud – there have been reports of finance providers falling victims and suffering large financial losses⁵.
⁵an example (from the world of trade finance) is the case of the Singapore oil trader Hin Leong
LEIs can be embedded into commercial payments or (to use a yet more examples mentioned by Stephan Wolf) embedding the vLEI into an e-invoice or even a vendor’s product factsheet.
Finally, an obvious use case for LEIs is sanctions checking. The expectation must be that the databases of sanctions checking applications are populated with LEIs. The processing required for the checking of parties against sanctions lists may become much more efficient, even be fully automated, reducing false positive results to a negligible percentage rate – but only if there comes a time when the use of LEIs is ubiquitous. Admittedly, at this stage it is a distant and remote prospect. Nonetheless if this were to happen, the process of checking a legal entity against a sanctions list would simply involve a machine determining if there is an exact data match. In other words, there will be only two possible outcomes: either the data matches or does not match. The wider ramifications would be that without an LEI a legal entity would effectively be excluded from the financial system (even if they were entirely legitimate and not subject to sanctions) but at the same time the transactions of an LEI which represents a sanctioned legal entity would be automatically flagged and rejected.
Although the full potential of the LEI has not been realised, it is beginning to have a transformative impact on the way transactions are processed, not least the world of finance. The modern financial system and the real economy needed new ways for counterparts to establish trust. By providing richer data in both quantitative and qualitative terms and by delivering processing efficiencies, the LEI can play a critical part in reducing the trade finance gap. Access to trade finance enables businesses to participate in trade. In the absence of trade finance, consisting of products and techniques for payment processing, risk mitigation and finance, many trade transactions would simply not be feasible.
*Associate member of the London Institute of Banking & Finance (LIBF); holder of the Diploma for Qualified Trade Finance Specialists (QTFS), Certificate for Documentary Credit Specialists (with ‘Advocate’ designation) (CDCSAdv), Certificate in International Trade Finance (CITF), Certificate for Specialists in Demand Guarantees (CSDG), Certificate in Supply Chain Finance (CSCF); holder of the Incoterms 2020® Certificate – awarded by the ICC Academy.
More articles and further information about me can be found on LinkedIn.
