How Can The Global Lei System Improve Transparency In Financial Markets?
The global LEI (Legal Entity Identifier) System is an identification framework of legal entities in the financial markets. In 2011, the G20 (group of Twenty) countries called on the FSB (Financial Stability Board), which oversees the global financial system, to come up with recommendations for a standardized identification system for legal entities. Therefore, in 2014, it established the global LEI system (GLEIS), where a 20-character code is issued to legal entities who wish to participate in the financial markets. This aims to ensure the global integrity of the financial system. The system is accepted by some jurisdictions already, and gradually more and more countries are adopting it.
Financial Crisis of 2008
The financial crisis of 2008, the increasing risk of money laundering, and terrorist financing entail the flaws and weaknesses in the global financial markets. In particular, the fall of the Lehman Brothers’ forced the financial oversight leaders to ponder about the entities involved in the transactions, their identification, and their overall structure. When Lehman Brothers collapsed, there were seventy-five other bankruptcy proceedings due to them because they were interconnected in cross-border and cross-entity transactions. The Brothers’ group was party to over nine hundred thousand derivatives contracts at that time, as indicated by Klaas Knot, at the GLEIF Meet the Market Event 2020.
When the group fell, there was no clear information on which institution owed what and to whom. This caused greater uncertainty in the financial markets because there was no uniform method to identify their information. Therefore, the Global LEI system was initiated which identifies the legal entities and their structure – involved in cross-border transactions – to map out the capital market participants which enhances the visibility of the transaction parties.
LEI System and Transparency in Financial Markets
There are numerous challenges to the global financial industry. One of the challenges is to access the quality, and scope of the financial information, provided by the clients. The financial institutions assess the financial information of the client and make a risk exposure profile. On the basis of risk profile, the financial institutions make a decision, whether to conduct transactions with the customer or not. Therefore, the quality and reliability of that information is very important. However, there was no standard system in place to recognize the entities and their structure, which would assist in accessing the client’s information.
Global Identification System
The LEI provides the identification of legal entities, answering the questions ‘Who is who?’ and ‘Who owns whom?’. This information ultimately maps the international financial ecosystem and provides a greater sense of transparency in corporate affairs. This also assists in the identification of legal entities in a financial transaction. The information may be accessed to verify the financial information provided by the client, and the financial institutions would be better able to complete the KYC/AML procedures. As the risk factor is an important measure in making a financial decision, therefore, the LEI system provides an enhanced level of insight and transparency to the financial institutions.
Reduction in Operational Cost
The LEI data is available in a central database, maintained by GLEIF, which is freely accessible for banks, credit rating agencies, and other financial institutions. The information is reviewed and updated annually, and also validated by the legal identity. Therefore, this will reduce the operational costs when a financial transaction is rejected due to incomplete information. The financial institutions may check their client’s history from the Global LEI database, and confirm the information needed for the cross-border transaction.
In 2017, the McKinsey&Company estimated that operational costs can be reduced by 3.5%, if the global LEI system is fully operational in the financial markets, particularly in the international banking industry. This means a saving of more than $150 million annually. Therefore, the global LEI system enables financial institutions to effectively monitor and assess their client’s information and come up with more accurate risk exposure. This also provides operational efficiency in terms of reducing costs. Therefore, the global LEI system assists in improving transparency in the international financial markets.
Accuracy of Information
The LEI system validates the legal entity data from official business registries. The Legal Entity Identifier needs to be renewed annually, therefore guaranteeing data accuracy. This information provides the financial regulators with an organized and unique database to access the market and financial integrity of their clients. As the LEI system is standardized, it gives a unique and easy understanding of the way to identify the entities involved in the global financial transactions.
Safety to Financial System
The global LEI system provides safety as well. The financial market participants can use the database information for a range of purposes. The most important use of the LEI is that the financial institutions can accurately identify their counterpart when engaging in transactions. The financial institutions can also use the LEI to keep track of the risk exposure profiles of the entities and make a sound decision based upon this information.
To conclude, the global LEI system provides unique identification to legal entities. It provides more accurate and reliable information about the parties involved in a transaction. The global database provides unified data, which financial institutions can use for a range of purposes. Therefore, the LEI Code greatly enhances the transparency in the global financial system.