The world has learned the hard way that it is in everyone’s interest to have a stable and transparent financial sector. In the aftermath of the 2008 financial crisis, the deeply opaque and convoluted nature of some financial products, bodies and mechanisms was recognized as a contributing factor. A patchwork of rules across different countries and financial centres made it difficult, time-consuming and expensive to identify all the legal entities or businesses involved in financial transactions. This, in turn, facilitated fraud and market abuse, and made it difficult to calculate financial risk.
In response, the G20 recognized the need to improve transparency across global financial transactions, and called on the Financial Stability Board (FSB) to help. The outcome was the creation of the Legal Entity Identifier (LEI): a unique code to identify individual businesses and entities. Crucially, this code worked across countries and sectors, reducing the opacity of the world’s interconnected financial networks. The Global LEI System was born and the first LEI was issued in 2012.
The beauty of the LEI is that it is unambiguous. An identifier – something like a financial fingerprint – is allocated to each business subscribed to the scheme. This 20-character alpha-numeric code is generated based on an International Standard (ISO 17442), and contains information about the entity, such as its name and ownership. Any LEI can be checked against a free, public database: the Global LEI Index.
The beauty of the LEI is that it is unambiguous.
A tool for today’s turmoil
Ten years on, the LEI is proving invaluable, as the financial sector once again faces instability caused by pandemic aftershocks, inflation, geopolitical turmoil and climate impacts. More innovative facets of the industry such as cryptocurrencies also raise questions around trust and safeguards. In this context, transparency is more important than ever – and LEIs can help.
US and European authorities now require corporations to use LEIs in their financial reporting, and they are mandatory for all companies trading in securities. LEIs make it easier to identify financial entities in a variety of settings – not only transactions, but also client onboarding, compliance reporting and risk monitoring. The use of LEIs also means higher-quality and more accurate financial data, putting authorities in a much better position to assess risk, identify trends and take corrective steps. Research from McKinsey has also shown that LEIs could save the global banking sector up to USD 4 billion, thanks to improved efficiency.
As we look to the future, technological innovations could make these fingerprints easier than ever to use. The “verifiable” LEI (vLEI) is a new digital counterpart of LEI which allows for identity to be verified entirely automatically, saving time and reducing human error.
But it’s not only today’s financial sector that stands to benefit from the increasing use of LEIs. They have been identified as a key tool in building sustainable future economies, which will rely on clear and accurate data to tackle climate-related threats and embrace opportunities.
The financial sector has a crucial role to play in climate action.
Our greatest challenge ahead: the climate crisis
The financial sector has a crucial role to play in climate action, but climate finance remains a serious challenge. Not only is there insufficient cash on offer from wealthier countries to support sustainable development in the Global South, but accessing climate finance can mean navigating a convoluted muddle of schemes, which is ultimately holding back climate-related spending. Beyond sustainable financing, there are many other issues to deal with. These include reducing the cost of green borrowing, reconceptualizing climate-related debt for poorer countries, calculating reparations for climate change loss and damage and ensuring a just climate transition. By improving financial transparency and enabling more accurate financial data, LEIs can play a role in addressing all of these challenges.
This potential was recently highlighted by the FSB: “The LEI is a key component for improving financial data, for instance to support a more accurate and timely aggregation of data on the same entity from different sources, especially on a cross-border basis. Adding the LEI of financial institutions’ counterparties in data reporting templates could contribute to increasing the reliability of climate-related data used and reported by financial institutions.”
In particular, the FSB pointed to how the expansion of initiatives such as LEI could be catalysts in identifying climate-related risks to the financial sector, which range from extreme weather events induced by climate change, to the impacts of disorderly energy transitions (which can leave costly stranded assets in their paths).
Alongside other ISO standards which were explicitly drafted to enable sustainable finance – such as ISO 32210 and ISO 14093 – ISO’s LEI standard can reduce friction, risk and opacity in global markets. As such, it has a significant and far-reaching part to play in helping the financial sector to combat climate change.
Looking to the future
In the coming years, there will be increased pressure on actors in the financial sector to take action to build trust and transparency into every transaction. The financial crisis of 2008 taught us that the financial sector does not operate in a silo, but is interconnected with everything else on the planet. It has the potential to cause devastation when matters fall out of control – but also the potential to help solve global challenges, and none more so than climate change.