Advancing Digital Identity in Financial Transactions

Part I: How the LEI can be leveraged to enable straight through processing, to strengthen the fight against financial crime and to prepare for a global digital identity ecosystem

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Today’s global financial ecosystem has evolved from humble beginnings. What started life as a system based on physical presence, handwritten documents and interpersonal familiarity has developed into an automated, multijurisdictional and increasingly digitized global environment. Yet despite the prevalence of digital transactions, the management of names, addresses and other financial identifiers required to authorize transactions is still conducted using analog, text-based processes.

With this post, we kick off a four-part blog series that dives into the world of financial trust and explores how the Legal Entity Identifier (LEI) can be leveraged to reduce global inefficiencies and enable faster, better and more cost-effective compliance with regulation aimed at preventing financial crime.

The genesis

What is now understood to be ‘the financial ecosystem’ traces back hundreds, if not thousands, of years. Then, stakeholders comprised of small numbers of merchants and bankers who, confined by geography and municipality, knew and trusted one another. Their identity was confirmed using hand-written signatures, which were considered to be marks of reputation as well as authenticity. On this basis, actors could quickly agree on rules and behaviors. Those that failed to comply were easily identified and excluded.

The industrial age brought scale

The dawn of the industrial age saw the democratization of banking services. Banks needed to develop networks of branches to enable the establishment of trusted local relationships at scale. Physical signatures continued as confirmations of trust, and banks began to rely on personal interactions with clients to deepen their customer assessments. Only a limited number of enterprises required international financial transactions. Postal services were widely used to exchange trusted documentation and, more recently, fax, telex and other electronic communication technologies were adopted, enabling an era of ‘electronic data interchange’. While other forms of document identification and authentication were also introduced, hand-written signatures remained the primary mode of confirming trust and providing legally-binding identification.

Digital transformation

The digital revolution has changed everything. Digital technologies have enabled true globalization, enabling instant connections between banking systems across geographic borders, and supporting transaction initiation from a wide range of electronic devices.

Digital banking is permanently changing banks’ relationships with customers and facilitating access to financial services like never before. Furthermore, the globalization of financial transactions has led to the development of a financial ecosystem where transactions across jurisdictions have multiplied. This is creating more demand for a financial ecosystem that is faster, more flexible and more agile.

The ID challenge

Digital transformation also requires stakeholders deal with new challenges relating to the management of trust and identity between transacting parties. A financial transaction is a transfer of resources between two endpoints or entities: the original owner of the resources and the receiving entity. The control of this financial flow relies on two essential elements:

1. The known identities of the source (original owner) and the destination (the receiving entity).
2. The precise nature of the transaction and the process for its execution (the underlying obligation and the flow of information required to fulfil the transaction).

The adoption of technologies facilitating digital transactions has created an imbalance in the ecosystem, since the processes used to identify the transacting parties still rely on names, imprecise text processing techniques, and manual intervention. For example, in payments transactions the original owner and the receiving entity may be identified by an account number and a name, neither of which are unique identifiers that would enable efficient communications with other banks involved in the transaction. This means that digital transactions are hindered because the parties are unable to perform the analog elements with the same speed, security and cost-efficiency.

Not only does this imbalance negatively impact the transaction user experience and the processing costs, it also exposes opportunities for fraudsters to exploit the system.

Banks are responsible for controlling the financial flows between the entities in the ecosystem and they do so according to watch lists of sanctioned entities published by the financial supervisory authorities. Banks analyze their transactions to find names of sanctioned entities in order to mitigate fraudulent and other illicit transactions. The fact that this remains an analog and text-based process means that the control of data is low, false alerts are frequent, and opportunities for wrong doing are widespread. Consequently, regulatory controls have become increasingly stringent and often now require banks to source additional, enriched data before they can authorize a transaction. In turn, compliance costs have increased substantially and efficiency in financial transactions has been reduced.

The LEI: Narrowing the compliance gap

The continued use of outdated technologies to operate and regulate global financial transactions risks creating a ‘compliance gap’, because these technologies are no longer fit for purpose in the fight against modern-day financial crime. Reliance on methodologies deployed in the brick-and-mortar world therefore, counteracts efforts to increase transparency and security in the global marketplace while exacerbating inefficiencies and commercial detriment.

In any financial transaction, the initial resource owner, the receiving entity and all the intermediary agents must be unambiguously identified throughout their exchanges of information, so their identities can each be verified. For legal entities, this can now be accomplished using the LEI – an enabling standard that, when universally adopted, promises to bring much needed efficiency to the digital financial transaction ecosystem.

In subsequent posts, we will explore how the LEI can be deployed to address these requirements, reduce the compliance gap, and rebalance the operational and regulatory technologies that underpin this digital financial age, enabling faster, better and more cost-effective compliance for all stakeholders. Specifically, we will investigate how the LEI can be leveraged to enable straight through processing, to strengthen the fight against financial crime and to prepare for a global digital identity ecosystem.

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