How Legal Entity Identifiers Will Transform Small Business in Asia
A unique, electronic, standardized ID platform will help Asian SMEs expand operations, join supply chains, and access credit.
Even within the financial sector, few are familiar with the term Legal Entity Identifier (LEI). Understandable, given that it’s hard to associate a directory of legal entities with high-quality information flows that meet regulatory requirements, increase the availability of credit, reduce costs, and help businesses grow.
Launched in 2014 by the G20 in the wake of the 2007-2008 global financial crisis and with direct oversight by the Financial Stability Board (FSB), the Global Legal Entity Identifier Foundation (GLEIF) is driving an initiative that nonetheless has the potential to transform the way we lend money, evaluate risk, or conduct business – all by simply inputting the LEI instead of a name.
The LEI establishes a unique, electronic, 20-digit standard identifier for legal entities that participate in financial and commercial transactions worldwide. Just like a passport or a car registration number, it provides a common and recognizable code that constitutes the building block for previously unobtainable data allowing legal entities to be identified and verified, and for information from various sources to be linked to this one identifier.
The entity registers its official name and registered address—as well as information about its ownership structure, including both direct and ultimate beneficial owners—on the GLEIF website, and information is to be updated annually (for a nominal fee). Entities of any size and business activity worldwide may register and searches are free for users.
Local operating units established worldwide explain the registration process and, crucially, verify the information supplied with local registries, business directories, and credit bureaus before allocating the LEI. The GLEIF is responsible for oversight, accuracy, and integrity of the LEI, and reports to the FSB and ultimately the G20.
So far, so dull. But people are beginning to take notice. It is already mandatory for participants in US capital markets to register, and the LEI will soon be adopted by regulators in the EU and India.
If we think a little deeper, the LEI does appear to have advantages. For instance, an October 2017 McKinsey report showed that a key cause of the 2008 crash was that financial system exposures were identified at an aggregate parent company/group level, not by legally distinct entities, for myriad reasons that are difficult for fast-moving financial institutions to control.
The LEI promises to harmonize this constant flow of information within a bank—whatever its size—because it provides a common traceable thread of identity, ownership, activities, and performance related to each individual entity to which the bank has exposure – all linked by the LEI and running through the entire organization. This would provide more precise data readily accessible in one place, reducing the time it takes to complete manual processes across multiple departments, subsidiaries, and functions.
Sharing coherent data will help the bank to enhance the management of risk. Higher quality information increases reliability (and reduces those many false positives) for compliance purposes.
The LEI will also expedite new relationships, clarify credit assessments, and make operational and market risk monitoring more efficient. And overall it will reduce costs.
Consider, too, a trading company, many of which are small and medium-sized enterprises (SMEs), with a typically cumbersome workload: concluding contracts; ordering goods, drawing up invoices; obtaining finance; securing raw materials; processing, manufacturing, packing, shipping, and distributing goods; receiving, making, and reconciling payments.
The LEI will help streamline such a work-intensive business because a company can collate information around a single entity—a customer, supplier, shipping company, or insurer—that all parts of the trading company can access. This will build a portfolio of previously unavailable performance and historical data by counterpart that will improve the reliability of its records over time.
As in a bank, a company can mitigate the risk of suspicious transactions or potential fraud, for example an attempted re-routing of funds, because it can refer to more complete details of previous dealings with individual entities.
The LEI will also help businesses grow. For a start, the GLEIF search capability enables companies to source and evaluate new buyers and sellers in target markets, encouraging them to expand their businesses with greater confidence.
Building such databases also helps large organizations to seek out new companies to transact with, including SMEs. This in turn creates more business opportunities for these companies which are already willing and able to participate in Asia’s supply chains.
However, ADB research has shown the majority of such businesses are less well-served by their banks because the local environment does not support or encourage uncollateralized lending.
Smaller entities often struggle to maintain full business records which help them obtain access to finance. A verified set of transactions with identifiable buyers and sellers will establish a track record of performance and payment that is far more valuable and relevant to the continuous, revolving nature of a trading company than a set of post-dated financial statements.
With these new sources of information, banks will be more willing to make early payments to small sellers and buyers. This will improve their cash flow, even in the absence of collateral and detailed, audited financial information, since SMEs in Asia can prove how well their business is actually run once data accumulate.
Up-to-date and reliable commercial information that emanates from the LEI would also underpin the spread of e-commerce in trade finance, a still nascent industry, especially in developing Asia.
Clearly, registration is only the first—albeit essential—step for this system to yield its full benefits.
The LEI would need to be adopted by all entities, not just financial institutions and trading companies: government departments and agencies, company, land and share registries, tax offices, sanctions lists, anti-money-laundering and know-your-customer directories, as well as auditors. Only then can truly comprehensive and meaningful portfolios of information be successfully constructed.
Banks can help drive global adoption among customers by persuading customers to register. They should target clients especially SMEs, helping them to grow their businesses and move into new markets, or where gaps in credit information have prevented small and otherwise successful businesses from obtaining finance.
With widespread adoption, the LEI will enable communication across different platforms since there will be one standard that all market participants can agree upon supporting the entire life cycle of transactions. But scalability will not happen if we all wait for somebody else to move first.
The ability to achieve these outcomes is directly related to the number of participants willing to engage with them. And the credibility of such networks will be undermined without the LEI.