Corporate Digital Identity Challenges for the Financial Market

For most people thinking about digital identity, the first thing that comes to mind is individual identity. Passports and driving licenses. But there is also the identity of things to safely exchange data from machine to machine and business identity to increase transparency of business transactions in the economy.

Business identity is undergoing a shift as business transactions have moved largely online. How does a business prove who they are when participating in financial markets? Until now, there has been some major challenges to verifying a corporate digital identity. Let’s talk about some of those.

Business name changes and insolvency

It’s not uncommon for businesses to change name, have multiple names for different jurisdictions or go insolvent and start up again with a different name but essentially be the same business. Primark, founded in the Republic of Ireland, was originally called Penneys. As Primark became a global brand, they could not use the name Penneys because the name was already owned by American retailer J.C Penney. Today, shops around the world are known as Primark, while the Republic of Ireland has retained the original name: Penneys.

This is a headache in corporate digital identity and it happens everywhere, often without transparency. For banks, approving business loans and large financial transactions, identifying a corporate entity with confidence requires skills similar to that of a detective.

Mergers and acquisitions

How do banks keep track of mergers and acquisitions? As two companies merge, the capital structure is subject to change. According to Investopedia:

“Many M&A transactions are also financed through the acquirer’s stock. For an acquirer to use its stock as currency for an acquisition, its shares must often be premium-priced, to begin with, else making purchases would be needlessly dilutive. As well, management of the target company also has to be convinced that accepting the acquirer’s stock rather than hard cash is a good idea. Support from the target company for such an M&A transaction is much more likely to be forthcoming if the acquirer is a Fortune 500 company than if it is ABC Widget Co.”

This largely complicated process could be made simpler and more transparent with better corporate digital identity. It could also mean that an ABC Widget Co company would be able to acquire another company without the need to be a Fortune 500 company because they have built a reputation on the financial market.

Cross-border consistency

In such a globalised financial market, it seems we are really behind on corporate digital identity. Every region and jurisdiction has a different way of logging and tracking a business and its activity. The formats for information are different and the information being taken is different. This means, when global transactions take place, information exchange is disjointed. Additional, manual work is needed to collect information and finalise a transaction.

I discuss more on the challenges of cross-border payments in this blog.

Lack of public information

In an ideal world, we could conduct business transactions with trust. Trusted business transactions mean you not only know who you are doing business with but you know that they will meet their legal obligations in a transaction because they have a history of doing so. But how do we really know this? Mergers and acquisitions, business name changes and insolvency issues make it harder to keep track of a business’s financial market history. This loophole has made it easier for criminals to evade the authorities and is largely why there is such a high level of money laundering on the financial markets today.

Some of these issues were discussed in a previous post about KYC.

Where does the LEI come into play?

On 20 July 2021, the European Commission presented an ambitious package of legislative proposals to strengthen the EU’s anti-money laundering and countering the financing of terrorism (AML/CFT) rules. The LEI is mentioned in two areas.

AML Regulation: Article 18 – Identification and verification of the customer’s identity – the LEI is required, where available, for the identification of a legal entity; for a trustee of an express trust or a person holding an equivalent position in a similar legal arrangement and for other organizations that have legal capacity under national law.

Revision of the 2015 Regulation on Transfers of Funds: Complete information on the payer and the payee should include the Legal Entity Identifier (LEI) when this information is provided by the payer to the payer’s service provider, since that would allow for better identification of the parties involved in a transfer of funds and could easily be included in existing payment message formats such as the one developed by the International Organization for Standardization for electronic data interchange between financial institutions.

The EU is recognising in these updates that the LEI has the potential to identify legal parties in a transaction, increase trust on the financial market and reduce fraud and money laundering.

The LEI has been recognised recently as beneficial to trade in a report by the B20 Italy, Business at OECD, and the IOE. The report was titled: “Trade Finance, a flywheel effect to boost the economic recovery post COVID-19 pandemic.

Importantly, the LEI, a global open data standard, does not contain confidential (private) information; therefore, it does not pose confidentiality threats in respect of information exchange. On the contrary, by providing a unique identifier, the LEI can help create an open and transparent ecosystem (e.g. for KYC purposes), where relevant financial institutions benefit from swift identification of new clients, while reducing duplicative work involved in having to gather themselves the information already captured by the LEI.

The LEI will be an important step in the progress towards trusted corporate digital identity, not just because it is an open standard, but because it is being endorsed by financial markets worldwide and quickly becoming the world’s global digital identity for business.

To learn more about the Legal Entity Identifier, click here. Or to get an LEI for your business, click here.

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