The LEI system emerged after the financial crisis of 2008 when the financial markets crashed after the collapse of Lehman Brothers, the world's fourth-largest investment bank. To ensure that this would not happen again, the G20 countries sent a request to the Financial Stability Board (FSA) for a system that would increase the transparency and stability of the financial markets. Today, the LEI system plays a major role in risk management and the management of fraud in the financial markets through a transparent, global system that can verify all financial transactions.
What is an LEI Code?
Companies that trade in securities must have an LEI Code. An LEI code is a unique alphanumeric code consisting of 20 characters. The numbers 1-4 tell which Local Operating Unit (LOU) issued the code. Characters 3-4 are reserved for future functionality as the system is still in development. Characters 7-18 consist of digits and letters that identify the individual legal entity and are unique to each individual company. The last two characters (19-20) are used for verification.
With the help of a Legal Entity Identifier, aka an LEI code in everyday speech, it is possible to identify financial transactions in a significantly safer, easier, and less expensive way. Before the comprehensive global LEI system was created, plenty of man-hours and manual work was required to be able to identify a trade. This validation and identification took place through information from often unreliable sources. The LEI system replaced this process and constituted an important foundation for the security of the financial markets and the reliability of consumers operating in the financial markets.
In the global LEI database at GLEIF, you can search for all legal entities that have an LEI code. Here you will find the following information about the company:
- Name of company
- Organization number
- Legal address
- Country of registration
- Legal form
- Parent company
- Status of the LEI
All LEI codes must be renewed once a year to ensure that the company data is up-to-date and correct. In this way, there is an up-to-date database for all legal entities worldwide that trade in securities. This increases transparency in the markets and makes it possible to reduce fraud by being able to identify both national and international financial transactions.
Why create a global LEI system?
For several decades, there has been a need for a system to identify transactions on the financial markets across national borders. However, this has been difficult to create. In the wake of the world economic crisis in 2008, the G20 countries sent a request to the Financial Stability Board (FSB) for a system that could help restore trust between consumers and the financial markets. In 2012, the RFS responded to the G20 countries' request with a report containing principles and developments for a global LEI system. This was approved by the G20 countries at the summit in June 2012.
The report described how the system can improve risk management in companies through better assessment of micro- and macro-risks, reduce market abuse and reduce financial fraud, while at the same time contributing to a higher quality of financial data across countries.
The various pieces of legislation dealing with entity identifiers
The requirement to be able to present an LEI code started for companies under the European Market Infrastructure Regulation (EMIR regulation), which was the starting point for the LEI system. According to EMIR legislation, all counterparties had to have a so-called "pre-LEI code". This was rolled out to ensure a smooth transition to the later MiFIR and MiFID II legislation.
In May 2014, new requirements came out when the MIFID directive came into force. This legislation focuses on increasing investor protection and increasing trading transparency by making the financial markets more robust, efficient, and transparent. Among other things, this directive contains authorization requirements for regulated markets, specific rules for the access of financial instruments to trading, and rules on specific behavior and organizational requirements for investment companies.
On 1 January 2018, the MiFIR regulation and the MIDID II directive came into force, which meant that all companies had to have an LEI code before buying and selling securities. According to the legislation, it is the securities traders who must be able to report LEI codes on both parties in all transactions. It was at this point in time that the LEI system really took off and became a new global standard.
The LEI system is still under development and lays the foundation for the security of investors trading in financial instruments. It also plays a major role in the workaround Know Your Customer (KYC), as it significantly simplifies the identification process and provides relevant and important information about the background of all legal entities that carry out transactions. This opens up new business opportunities and increases operational efficiency for many large financial firms.