The LEI as 'the KYC layer' to a CBDC system

Published on 8 March, 2022
By LEI Worldwide

Applicability of the legal entity identifier (lei)

as the kyc layer to a cbdc system

The Legal Entity Identifier (LEI) is a 20 digit corporate digital identifier that helps us accurately and quickly verify the identity of any company. 

An LEI code is reported by regulated counterparties to financial transactions to clearly identify ‘who is whom’. The LEI is backed by the G20 Nations, Financial Stability Board (FSB), openly supported by institutions such as the European Central Bank and the Bank of England. It is also an official ISO standard 17442

Why is there a need for the lei?

Use of the LEI is mandated for market participants by over 116+ regulations worldwide, including those engaging in securities transactions, derivatives and financial instruments trading, amongst many others. You can find a list of regulations and more about who needs an LEI here. 

However, the applicability of the LEI extends much further than that. It has been described as a “swiss army knife for the worlds digital economy” by the GLEIF. 

By broadening the adoption of the LEI to more industries and use cases we can fully experience the benefits of having an economy with access to much higher data quality around identity.

by McKinsey that the LEI could save banks up to 2-4 billion Dollars annually in KYC processes).

Until now, innovation has been stifled by the fact that there has been no global authority capable of establishing universal digitised trust between organisations doing commerce across borders. 


This includes the use of a blockchain based payment rail for B2B transactions, as most ‘crypto’ wallets come with an untraceable ID and are suited only to transactions between individuals, and not organisations.


​Although there are many identifiers out there, none posses the mark of trust which can be delivered by the LEI. 

ENTER THE vLEI

The introduction of Digital Certificates (e.g SSL), were a step in the right direction towards providing security around who is safe to do business with online. However they also fell slightly short of the mark when it came to having up to date, unique, current and high quality data.

The vLEI has the potential to become one of the most valuable digital credentials in the world; it will be the hallmark of authenticity for all legal entities everywhere.- GLEIF

The vLEI is an adaptation of an LEI which is based on a verifiable credential. The vLEI is a fully digitized form of the LEI which enables instant and automated identity verification between counterparties operating across all industry sectors, globally.

Based on a concept known as self-sovereign identity (SSI), the vLEI will be applicable to be embedded with most blockchain applications and none more perfectly suited to that of a Central Bank Digital Currency (CBDC).
 

What is an LEI number used for? LEI Codes are simply used to identify legal entities on a global scale. This allows for great transparency in financial markets, standardisation, and greater risk control.​

According to LEI ROC the LEI no. was conceived to be used by the private sector to support improved risk management, increased operational efficiency, more accurate calculation of exposures, and other needs.

​One centralised source of information, that contains vast amounts of attainable, high quality data.

If you would like to find a more detailed explanation of the Legal Entity Identifier System, you can read our recent post What is an LEI number?

 

WhAT IS a CBDC?

With the rapid digitisation of the global economy new innovations are surfacing which unlock pain points and replace outdated processes. Sometimes these innovations fit together perfectly, in this case we will look at the applicability of the LEI acting as the KYC layer to Central Bank Digital Currencies.

There has been much talk of the development of CBDCs in the last 6 months. Just yesterday, Thursday, 20th Jan 200 the US Federal Reserve released a new white paper on Central Bank Digital Currencies.

The paper outlines the key steps leading up to what could eventually become a US digital dollar. The launch of the Digital Pound Foundation (DPF) opens the floor to private and public sector organisations to collaborate on the development of CBDCs within the United Kingdom.

Accenture is an associate member of the DPF, and they are also piloting the Digital Dollar Project. The Bank of England have appointed Accenture to head up the revamping of their RTGS settlement system, which is set to include a feature making it applicable to CBDCs. Other experiments are being carried out by almost all major banking institutions, the BIS, Bank of France and Swiss National Bank have even successfully concluded a cross-border wholesale CBDC experiment. 

LEIs help businesses link data sets, improving analysis. Building a complete picture of a business, by linking its data, could also help small businesses to access finance. We will champion the LEI as a globally recognised identifier for all businesses in the UK.

- The Bank of England

A Central Bank Digital Currency (CBDC) is essentially the digital form of a country's fiat currency, which is regulated by its central bank. B2B based transactions are currency only identified using the LEI in a regulated setting, but now that we have automated LEI issuing technologies such as RAMP 2.0 we can swiftly and easily roll out LEIs to all companies engaging in all financial transactions. Any CBDC would want to roll out LEIs to their clients in a worldwide manner, and RAMP 2.0 is the only RA model software capable of doing so on such a global basis.


The Bank of International Settlements (BIS) released their CBDC for cross border payments last year and listed the Legal Entity Identifier as a means to standardising digital identity for legal entities. 

Benefits of using the LEI include:

  • Instant reconciliation of payments
  • Greater transparency for AML
  • Streamlines onboarding and KYC
  • Interoperable with blockchain apps
  • Globally recognised and standardised
  • Open source data
  • Build into Smart Contracts
  • Already widely used in regulated industries
  • Multiple use cases, many yet undiscovered

The Problem

Money is currently being created as debt, 97% of the money that exists in the world is created as a result of printing within the traditional banking system. In the normal way money is created money has to be paid back with interest. Were all debts to fall due at the same time, like a game of musical chairs someone is left standing. This is an issue within the current traditional banking system. 


Traditional cash is currently highly untraceable and is being spent illicitly, or on illegal activity such as fraud, money laundering and terrorism. Players within the system who would be inclined to behave outside the legal framework fly under the radar and can hide their identity underneath a network of international shell companies and bank accounts. 


Cross-border payments are currently criticised for having a high cost, low speed and inadequate transparency. Traditional mainstream cryptocurrencies do not solve this problem either. 
The US Federal Reserve stated in their CBDC paper ”Many cryptocurrencies come with a significant energy footprint and make consumers vulnerable to loss, theft, and fraud.”​

Banks also currently face delays when onboarding new clients for the same reason. In a bid to block or prevent such activity they are required to conduct mandatory AML checks to verify who is entering the system. Having spoken recently to a major investment bank we discovered that banks find it especially difficult making payments to entities outside their organisations ecosystem, because they simply have no standardised way of verifying the account and authorised signatory. 


Current #AML #KYC and compliance requirements cause liquidity delays, beneficiaries have little information to automate reconciliation which is done manually, identity issues such as 'payment on Behalf Of' (POBO) result in time-consuming workarounds.


We have also discovered through conversation with industry partners that banks maintain in house entity data on their clients which is often outdated or inaccurate and have a real issue in keeping it accurate. 

THE SOLUTION

CBDCs are currency created without debt, this delivers the attendant benefits that do not exist in the current paradigm.  

It is also a currency based on a blockchain system which is a fully traceable and auditable system. A CBDC currency can be programmed to be spent in accordance with behavioural economics. Incentivising some behaviours, disincentivising others in order to stimulate the economy and prevent so called dirty money from entering the system. 


A CBDC based cross-border transaction system would minimise the current high cost of transactions to almost zero, speed up settlement times to instant and provide total transparency. 

The delays caused by the absence of a globally recognised verifiable digital identity can all be streamlined by access to reliable, accurate data such as the Legal Entity Identifier database. The LEI helps identify debtors and creditors in transactions quickly, easily and reliably. 

In a recent interview, Merlin Dowse of J.P Morgan stated “Corporates have to connect with multiple providers, each of which issues them with a client reference number that is meaningless outside of that provider’s system. Every time they interact with a third party, they have to share their information again. Reducing all of this to one unique identifier in the shape of the LEI allows for interoperability across networks and removes friction, saving time and costs.”

Were a CBDC ecosystem to adopt the LEI as its KYC layer, counterparties and regulators would have realtime access to total transparency of who is transacting, and moreover, have access to information regarding the organisational structure provided by 'Level 2' LEI data. It would work similarly to the way the IBAN currently functions, except it links to a publicly accessible database containing vital reference data on the account owner. 

One of the foremost problems a global financial system based on CBDCs would solve is the liberation of capital held up in reserve by Nostro-Vostro accounts. Real-time settlement of funds cross borders would invalidate the need for such accounts, and that capital would be freed up releasing over $30 trillion USD back into circulation globally.


The LEI or vLEI and CBDC combination will not just speed up the authorising of payments, but rapidly increase settlement and reconciliation time of international payments.

This combination also will massively enhance AML due diligence process, especially if the vLEI is to deliver on its right to represent verification feature. This will reduce fraud, money-laundering and overall risk exposure. 

CBDCs using the LEI as a KYC layer harness the benefits of cryptocurrencies, blockchain and distributed ledger technology, while mitigating the downsides they present to a normal, healthy functional banking system.


We have already made progress towards this end as GLEIF are signed up to the latest standards in real time settlement of cross borders transactions 'ISO 20022', which is set to be followed by CBDCs or any other innovative method of transacting that may come along in this exciting new era of change. 

@livewireAssets