Electronic communication continues to grow in importance as a tool to support trade in goods and services, in particular between buyers and sellers based in different countries. Banks, for example, have notably extensive experience in this area, while public administrations are increasingly developing e-government services for their domestic needs. As the supply chain has become international, the need has arisen for global standards to define the identities of trading partners for the purposes of invoicing, customs declarations and payments. Businesses, consumers and government agencies are all faced with the challenge to understand ‘who is who’ in the digital and global supply chain. This requires a global approach to identity management.
This blog post is an excerpt of the author’s article titled ‘The Digital Identity of Legal Entities: Current Status and Way Forward’ published in the Journal of Payments Strategy & Systems (Volume 12, Number 1). Whereas the full article provides in-depth background information on various aspects relevant to identity management, this excerpt focuses on the use of the Legal Entity Identifier (LEI) in payment systems. The full article is available for download (see ‘related links’ below).
Identity management for payment systems
Identity management has always been an important building block for electronic payments systems in order to manage the operational risks of the scheme and for the scheme participants. The Financial Action Task Force (FATF) recommendations on combating money laundering and the financing of terrorism on the legislation in any jurisdiction have increased the need for an end-to-end approach on identity management for payments. Scheme participants must, among other things, be responsible for high-quality data on their customers for the purposes of customer due diligence, record keeping and wire transfer processes.
For retail payment systems, the trend is towards the further unbundling of the payment process as a consequence of legislation (such as the Second Payment Services Directive in the European Union (EU), with the creation of licensed payment initiation service providers) and market developments like overlay service providers. All direct and indirect participants of retail payment schemes and systems need to ensure that correct customer data is used for the transfer of funds (domestically or cross-border). The quality of the data from participants of national or international payments schemes too often fails to meet the high-quality standard that supervisors require for their licensed financial institutions.
Principle 22 of the principles for financial market infrastructures (PFMI) states that “an FMI should use, or at minimum accommodate, relevant internationally accepted communication procedures and standards to facilitate efficient payment, clearing, settlement and recording”. The principle does not, however, clarify what the international standard should be for legal entities and for natural persons and what the data quality level should be for scheme participants in order to meet the requirement of the overseers. The ISO 17442 LEI standard is an international standard for legal entities, but for natural persons there is not yet a standard available. Because most payment scheme participants have an LEI already, the addition of the high-quality LEI to the file of the scheme participant could improve risk management for the scheme owner (scheme manager) without additional cost.
Cards are important identification and payment instruments for consumers to buy goods and services from online merchants. For card issuers, an LEI mapping service with the ISO 7812 identification standard for issued cards could improve data quality. Among too many compliance officers of card acquirers, card processors and card schemes, there are strong signals that the quality of merchant data fails to comply with the Payment Card Industry Security Standard (PCI). Access to high-quality merchant data is in the interest of consumers in terms of the know your supplier (KYS) principle and of card scheme participants to aid the management of their operational risks. Adding the LEI to the PCI requirements could reduce the operational costs and risks associated with card schemes for their acquirers and processors.
Costs and risks of identity management
Businesses, in particular their data managers, compliance officers and procurement officers, have become aware of the substantial costs and potential risks involved in managing the data of customers and suppliers.
Many banks have multiple IDs for the same business partner, such as a national government-issued business registration number, VAT number (in the EU), Employer Identification Number (in the USA) or industry-issued number such as the ISO BIC, DUN, PERM ID etc. The attributes of those registration numbers may not be exactly the same. In addition, it is not clear how a legal entity fits into its group structure.
To overcome the data-quality challenges in the supply chain, the LEI could add value for all parties engaged in commercial transactions. There is no other global, open legal entity identification system with such a strict regime of regular data verification to ensure the high quality of its data. The LEI data record also gives insight on the national business registration number in addition to the direct and/or ultimate parents — if available — of that legal entity.
It is estimated that banks active in trade financing could save US$500m per annum by using the LEI in trade finance and the issuance of letters of credits alone, with other potential benefits also possible.
The way forward
The supply chain is becoming increasingly global and digital. This requires a stronger system for the identification of trading partners for public purposes and private purposes. The LEI is a promising candidate because it is a high-quality identifier of legal entities that is provided free of charge to any user.
Where web merchants add their LEI to their website (preferably on the payment page), this would benefit consumers as it would meet the KYS requirements of consumer organizations.
Business, meanwhile, would benefit if their counterparties in the supply chain have an LEI because this would reduce the onboarding and maintenance costs of their customers and suppliers and reduce their operational risks.
Banks (and other financial firms) would benefit if their business customers had an LEI because this would facilitate the onboarding of those customers and the maintenance of customer data. Banks would benefit even more if correspondent banks, the financial market infrastructures and real-time gross settlement systems to which they are connected included the LEI in their messages because this would make their risk management and liquidity management less costly due to lower operational risks.
Payment schemes and automatic clearing houses (clearing and settlement mechanisms) would benefit from the addition of LEIs to the files of their participants and customers as this would reduce operational risks. In addition, the inclusion of the LEI of businesses in the scheme-rules of the rulebook and in the clearing messaging service would create additional added value for banks that are keen to deliver better payment reporting services to their business customers. The inclusion of the LEI of the business customer in a credit transfer will make the reconciliation of such payments easier during the incoming cash-management process of those businesses and government treasuries that receive the payment message.
Card schemes, card acquirers and card processors would benefit were the LEI included in the PCI requirements as this would reduce their operational risks.
All participants in the supply chain and the public sector would benefit from a global ISO standard for natural persons. The ISO TC 68 Financial Services needs to be encouraged, as was done for the LEI standard, to develop such a standard to facilitate the processing and storage of data on natural persons (from different jurisdictions) for public and private purposes. However, the creation of a global register for natural persons is not recommended because of data-protection challenges.
As rule-maker of the PFMI Principles, the Committee on Payments and Market Infrastructures is encouraged to specify in more detail the ‘internationally accepted standards’ for legal entities and natural persons for the efficient payment, clearing, settlement and recording of the payments and card payment business to ensure efficient, safe and innovative payment systems for society.
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Gerard Hartsink was appointed by the Financial Stability Board as Chairman of the GLEIF Board. The profiles of Gerard Hartsink and all other members of the GLEIF Board of Directors are available on the GLEIF website.
