Could the Global Legal Entity Identifier Be Useful for Financial Transparency Legislation in the 116th Congress?

Could the Global Legal Entity Identifier Be Useful for Financial Transparency Legislation in the 116th Congress?

October 22, 2019
Could the Global Legal Entity Identifier Be Useful for Financial
Transparency Legislation in the 116th Congress?
Overview
Although the origins of the LEI stemmed from concerns
The 116th Congress is examining legislation related to
over credit risk and safety and soundness that surfaced
financial transparency. This has come in the form of bills—
during the 2008 financial crisis, the LEI may also have
H.R. 2513, S. 2563, S. 1978, or S. 1889—that would
additional benefits for financial transparency. A May 2018
mandate greater disclosures of the natural persons or
study from the Global Legal Entity Identifier Foundation
“beneficial owners” who benefit from or control a
asserted, based on multiple interviews with financial market
corporation or similar legal entity. Other bills, such as H.R.
companies, that the lack of consistent, reliable automated
4476, seek to promote financial transparency and data
identifiers was creating a great burden on the financial
standardization among securities, commodities, and
industry; that most in the industry believed the “Know Your
banking laws to make information reported to financial
Customer” process of onboarding new clients would likely
regulatory agencies more easily electronically searchable.
become more automated; and that “there is clearly an
The global Legal Entity Identifier system, increasingly used
opportunity to align on one identifier to generate
in the financial sector since its 2009 inception, but
efficiencies.” Similar conclusions were reached in a 2017
seemingly little known among broader audiences, may be
study by McKinsey & Co. The current LEI system is aimed
of interest to Congress in light of such legislative activity.
more at tracking financial transactions of various affiliates,
but such a unified global identifier might be useful for more
What Is the Legal Entity Identifier?
easily tracking ownership of affiliates, or of newly created
The Legal Entity Identifier (LEI) is a tool aimed at
corporate entities.
promoting transparency and improving risk management in
the international financial system. Its origins stem from
As of July 2019, more than 1.45 million LEIs have been
problems highlighted by the 2008 financial crisis. These
issued to entities in over 180 countries, worldwide.
included excessive opacity in credit risks, and the huge,
However, use of the LEI remains largely voluntary. In the
hard to measure, losses accrued across affiliates of large
United States and abroad, only some aspects of financial
financial conglomerates. For example, when Lehman
reporting require use of the LEI. Nevertheless, LEI usage in
Brothers failed in 2008, financial regulators and market
a wide range of disparate U.S. regulations is growing.
participants found it difficult to gauge their financial trading
counterparties’ exposure to Lehman’s large number of
Policy Issues
subsidiaries and legal entities, domestically and overseas.
Some have called the lack of a widespread adoption of a
To better track such exposures, the Financial Stability
common legal identifier a collective action problem. In a
Board (FSB) and G-20 helped design and create the LEI.
collective action problem, all participants in a system
benefit if everyone participates; if only a few participate,
The LEI is a voluntary international system assigning each
those few bear high costs, as early adopters, with little
separate “legal entity” a unique 20-digit identifying
benefit. Collective action problems are examples of
number. This number can be used across jurisdictions to
situations where a government-organized solution may
identify a legally distinct entity engaged in a financial
result in more widespread benefits. Some academics have
transaction—including a cross-border financial transaction.
urged regulators to mandate LEI usage in regulatory
This makes it potentially useful in today’s globally
reporting as a means of solving this collective action
interconnected financial system. The LEI was designed to
problem. The federal Office of Financial Research noted
enable risk managers and regulators to identify parties to
that, “Universal adoption is necessary to bring efficiencies
financial transactions quickly and precisely.
to reporting entities and useful information to the Financial
Stability Oversight Council, its member agencies, and other
The LEI’s unique identifying number acts as a reference
policymakers.”
code—much like a bar code—which can be used globally,
across different types of markets, and for a wide range of
Various potential policy problems could arise if multiple
financial purposes. These could include capital markets and
financial regulators each created or mandated their own
derivatives transactions, commercial lending, and customer
unique legal identifier. This could result in redundant
ownership, due diligence and financial transparency
paperwork and extra compliance costs for businesses. It
purposes; as well as risk management purposes for large
could also obscure, rather than clarify, analysis of complex
conglomerates that may have hundreds or thousands of
webs of financial transactions among multiple legal entities
subsidiaries and affiliates to track. A large international
if those entities could choose among identifiers. Finally,
bank, for example, may have an LEI identifying the parent
multiple identifiers could pose additional challenges to
entity plus a different LEI for each of its legal entities that
industry and regulators’ technological efforts underway to
engage in other financial transactions.
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Could the Global Legal Entity Identifier Be Useful for Financial Transparency Legislation in the 116th Congress?
use data in analyzing compliance and enforcement issues in
including whether and how to promote this to enhance data
the financial sector.
analysis and new technology adoption in the financial
sector; and (2) beneficial ownership disclosure issues. H.R.
Current Uses of the LEI
4476, introduced September 24, 2019, would mandate that
The LEI is being used globally, but, as of the end of
each financial regulator take steps to standardize the data it
January 2018, LEI coverage was concentrated in Canada,
collects from industry, and that the data each agency
the European Union, and the United States. According to a
collects should include standard identifiers. As noted in
May 2019 FSB study, legal entities in the United States had
H.R. 4476, the data standards promulgated by each
registered for the most LEIs, at 14.4% of the total; followed
financial agency “shall include a common nonproprietary
by the United Kingdom at 10.8%; Germany at 9.2%; and
legal entity identifier that is available under an open
the Netherlands at 8.3%.
license.” It is not entirely clear whether the LEI would be
one possible such identifier. The bill states that the agencies
In the United States, the LEI is increasingly being adopted
should “incorporate standards developed and maintained by
both voluntarily through industry practice and regulatory
voluntary consensus standards bodies”—which might
measures for a disparate range of purposes in the financial
potentially include the LEI. It does not appear that all the
sector. The Regulatory Oversight Committee of the LEI
agencies must agree on one universal identifier as opposed
found that as of April 30, 2018, there were 27 instances in
to each agency choosing or creating their own identifier.
U.S. rules or statutes where use of an LEI was either
required, requested, or recommended. Its use spans the
Bills—such as H.R. 2513, S. 1889, S. 1978, and S. 2563—
payment and mortgage systems, securities and derivatives
that deal with beneficial ownership disclosure would
trading, electricity, banking, and other sectors. A few
mandate that persons who form corporations or limited
examples include the following:
liability companies in the United States disclose the
beneficial owners of those entities. The bills generally
 Securities and Exchange Commission (SEC) rules
require that such ownership information be reported to the
requesting investment advisers use the LEI when
Financial Crimes Enforcement Network (FinCEN) within
submitting certain disclosure forms to the SEC;
Treasury, which would store this information in a database.
 SEC rules on holdings by money market funds;
S. 1889 and S. 1978 do not specifically discuss a type of
 Commodity Futures Trading Commission (CFTC)
standardized numeric “identifier.” S. 2563 creates a
rules on reporting derivatives transactions;
“FinCEN identifier,” a unique identifying number assigned
 National Association of Insurance Commissioners use
by FinCEN to a person reporting their ownership of a
of LEI on forms describing investment counterparties;
corporation or limited liability company. It appears that the
 Consumer Financial Protection Bureau rules requiring
identifier would be used by FinCEN to mask the actual
some home mortgage lenders obtain and report LEIs;
name of the person with a number; but it is unclear if such
 Bank regulators’ requirement that certain banks with
FinCEN identifier would be used for any further purpose.
deposit insurance obtain and report LEIs; and
H.R. 2513 would also create a “FinCEN ID number to any
 Federal Energy Regulatory Commission rules that
individual who requests such a number and provides
some electricity market participants obtain LEIs.
FinCEN with the information…” (required to prove
identity). Both H.R. 2513 and S. 2563 would require any
The FSB’s May 2019 review on LEI usage found that
individual with a FinCEN ID number to submit an annual
globally, the LEI was used to identify participants in nearly
filing with FinCEN updating their identifying information.
100% of the total dollar amount of over-the-counter
derivative trades in most developed countries. Globally,
The FSB’s May 2019 review argued that LEIs could prove
about 78% of the total dollar amount of debt and equity
useful for AML and ownership disclosure purposes, such as
issued in these countries came from issuers with LEIs.
in these bills. FinCEN’s May 11, 2016 final rule imposing
certain beneficial ownership disclosures on corporate
But FSB found that, where regulatory adoption mandates
entities opening bank accounts rejected a commenter’s
were absent, LEI adoption and maintenance (or updating)
suggestion to require use of the LEI on the beneficial
rates have been significantly lower. According to FSB,
ownership disclosure form financial institutions submit to
usage has been low outside securities and derivatives
FinCEN. FinCEN wrote that the vast majority of legal
trading, despite the fact that “higher LEI coverage
entities subject to such disclosure would be small or
(including for nonfinancial corporations) would support
nonfinancial entities unlikely to otherwise apply for LEIs
regulatory uses such as for AML (anti-money laundering)
and that the costs of mandating an LEI solely for the
and CFT (countering the financing of terrorism), as well as
purposes of FinCEN’s form would thus exceed the benefit.
other business and industry uses such as know your
FinCEN stated other challenges are that the body assigning
customer (KYC) processes and the transfer of funds,
LEIs does not require the beneficial owner to be a natural
especially across borders.” Moreover, the lack of
person, (as opposed to another legal entity); that they use a
widespread governmental requirement has limited the LEI’s
50% ownership threshold as opposed to the 25% threshold
usefulness in capturing positive externalities for the market
used by FinCEN; and that they do not verify identities of
as a whole and for regulators.
beneficial owners—thereby rendering the LEI’s utility as an
alternative source of verification minimal.
Congressional Issues
The increasing usage of the LEI is relevant to two areas of
Rena S. Miller, Specialist in Financial Economics
recent interest to Congress: (1) data standardization,
IF11341
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Could the Global Legal Entity Identifier Be Useful for Financial Transparency Legislation in the 116th Congress?

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