How the Legal Entity Identifier (LEI) Could Help African SMEs Fight Fraud, Secure Trust and Facilitate Access to Finance

In his second blog (first blog here) for Making Finance Work for Africa, Stephan Wolf, CEO of the Global Legal Entity Identifier Foundation (GLEIF) discusses how the LEI can create added value for African SMEs by securing trust in today’s complex web of business transactions. He also explains how identification through the LEI can minimize de-risking, fight against fraud and facilitate African SMEs’ access to finance.

In many jurisdictions, small and medium-sized enterprises (SMEs) make up the majority of the economy. In the European Union, for example, these entities represent 99% of all businesses while in Africa, SMEs represent more than 90%[1]. Although the exact criteria and definition of an SME changes from one jurisdiction to another; they share some common difficulties. These include, unlocking access to finance essential for growth and survival, and gaining the trust of investors, suppliers and customers with limited means and resources. The Legal Entity Identifier (LEI) could be a game changer for SMEs in overcoming these barriers.

The LEI’s potential transformative role for SMEs has already been widely recognized by key industry stakeholders. A recent survey by the Trade Finance Program of the Asian Development Bank on Legal Entity Identifier Accessibility, emphasized the power of the information linked to the LEI and how it could be exponential for SMEs in the developing world.

In addition, the International Trade Center’s Promoting SME Competitiveness in Africa: Data for De-Risking Investment report states that: “In times when transparency and availability of data are at a premium, greater efforts have to be made to ensure that national stakeholders in African countries have the necessary information to signal SME reliability and attractiveness to potential international investors.” The publicly available LEI data pool could be the key building block for establishing the foundation of trust for African SMEs.

According to the report, one of the biggest challenges that the African continent and especially SMEs face is the existence of a significant investment gap due to investors’ risk perception associated with ‘informality’. Investors do not invest in unregistered firms, which make up a significant proportion of African SMEs. The report confirms that better data could reduce this investment risk significantly.

By leveraging the LEI issuance process and network of accredited LEI issuers in Africa, firms could overcome this ‘informality’ gap by registering for an LEI.

1) Accurately identify your company and counterparty with the LEI: Business relationships today are not limited by where a legal entity is domiciled. According to the World Trade Organization’s World Trade Report 2016: Levelling the Trading Field for SMEs, the spread of online platforms and electronic commerce promises to give SMEs the ability to reach customers around the world. On average, 97% of internet-enabled small businesses export.

Trust is the key component of a thriving SME ecosystem. It is crucial for these entities to prove who they are and to know precisely who they are doing business with. The use of LEIs to accurately identify their customers, suppliers and other counterparties, enables SMEs to use their limited resources effectively. An LEI could help an SME reach the decision that a supplier is a legitimate entity that is legally and strategically ‘safe’ to buy goods or services from.

Although a national identifier can prove that a company exists in a local jurisdiction, entities often face difficulties in proving their existence to their overseas suppliers, investors and customers. The LEI, an internationally recognized global standard, provides a company with the opportunity to prove its credentials. The LEI can provide information on a company’s legal name, where the company is registered and what parent information the company has. It does this in a standardized and machine-readable format. As an ISO standard, the LEI easily complements what already exists (such as national identifiers generated from registry systems) while at the same time serves the passport functionality across borders and reduces the informality associated with risk.

The information provided in an LEI’s reference data is verified and validated by LEI Issuing Organizations, accredited by GLEIF. GLEIF operates under the Open Data Charter terms, which means the data that are freely accessible to all users without limitations. The complete database of LEIs and the associated LEI reference data is available free of any charge or barrier to anyone.

2) Leverage LEI for accessing finance: Accessing sufficient finance is one of the major bottlenecks for SMEs to survive, grow and internationalize. The recent FSB (Financial Stability Board) Action Plan to Assess and Address the Decline in Correspondent Banking Progress Report finds that correspondent banking relationships are in decline in many regions, with East and South Africa among the three most affected regions. The decline is worrying as it could have serious consequences on growth, financial inclusion and international trade, particularly for SMEs. The International Finance Corporation’s Navigating Essential Anti-Money Laundering and Combating the Financing of Terrorism Requirements in Trade Finance: A Guide for Respondent Banks rightly suggests that a respondent bank “might consider adopting/obtaining LEIs in order to improve its [know your customer] KYC profile to correspondent banks”. In jurisdictions where national business registries are not as organized, the encouragement or requirement for market participants to submit their LEI could be beneficial for both the bank and the client. Collection of LEIs from all involved entities could help the bank to automate customer information collection as part of the KYC process. For SMEs, this means a higher chance of accessing financing opportunities.

3) Go digital with LEI and prevent the risk of fraud: Digital identification schemes and digital verification are thriving in every corner of the world. In Africa, Kenya just created the continent’s first national digital ID scheme in 2019. Ensuring that identification is based on accurate data and built on trust is key for any digital identification scheme to succeed. LEIs can be easily integrated into any digital certificate assigned to individuals acting in an official role to easily identify the legal entity they represent. For example, the GLEIF annual report 2018 has been signed with eIDAS (electronic IDentification, Authentication and trust Services, an EU regulation) compliant certificates. These certificates, for the first time, connect the role of the signatory to an organization through the LEI and can therefore be used to verify – automatically, through the shared LEI – that the filed document and the signatories represent the same organization. Incorporating a company’s LEI within digital certificates of its executive officers (e.g. CEO) which are used to sign financial statements provides reassurance on the data’s reliability and that the information has not been tampered with, despite permitted access to the filed document via any public server globally. Deploying digital signatures, including that of the auditor, also enables efficient report production and distribution processes, the elimination of paper and increased certainty and trust.

In parallel with the digitization and adoption of digital certificates in Africa, African SMEs could enjoy more benefits associated with the LEI and prevent the risk of fraud in the documents or contracts that they submit or execute.

To find out more about the LEI please visit the GLEIF website: https://www.gleif.org/en/