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#3 in the LEI Lightbulb Blog Series - European Commission Weaponizes the LEI in its Battle Against Money Laundering and the Financing of Terrorism

A new package of EC legislative proposals harnesses the LEI as a transparency tool to help protect EU citizens from the consequences of illegal money flow and the financing of terrorism

Author: Stephan Wolf

  • Date: 2021-08-03
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In July 2021, the European Commission (EC) moved one step closer to a clampdown on illicit money flows; it published its long-awaited package of four legislative proposals intended to strengthen the EU’s rules on anti-money laundering and countering the financing of terrorism (AML/CFT).

Within the package, the EC officially recognized the value of the Legal Entity Identifier (LEI) as a unique mechanism capable of supporting transparency within any ecosystem, by formalizing it as an important component of future AML/CFT efforts. Two of the four EC proposals call for the LEI to be used in certain customer identification and verification scenarios where it is available:

  • New Regulation on AML/CFT: Proposal for a Regulation of the European Parliament and of the Council on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing;
  • Revision of the 2015 Regulation on Transfer of Funds: Proposal for a Regulation of the European Parliament and of the Council on information accompanying transfers of funds and certain crypto-assets (recast).

Inclusion of the LEI within such far-reaching, EU-wide proposals for a future-proof AML/CFT regulatory framework represents a huge leap forwards, in terms of realizing a key component of the G20 and Financial Stability Board’s vision to create the LEI as a public good. Any role played by the LEI in helping to protect EU citizens from the impact of terrorism and organized crime can be deemed of significant societal benefit.

A brief analysis of why the EC is championing the LEI within the AML/CFT context highlights that there are many benefits. Use of the LEI consistently for entity identification at the Member State level and the EU level can diminish the margins-of-error related to language ambiguity, human interpretation, and manual intervention. The LEI’s broad interoperability enables it to be integrated seamlessly into both centralized and decentralized digital identity management systems, together with the eIDAS-compliant digital certificates that are already harmonizing the use of e-signature technologies across the EU.

Beyond that, the new EC proposals are intended to create a much more consistent framework to ease compliance for operators subject to AML/CFT rules, especially for those active cross-border. Here too, and given the cross-border nature of money laundering and terrorism financing, the LEI can be used as the ‘Rosetta Stone’ for legal entities involved in financial transactions. Overseen by the Regulatory Oversight Committee (ROC), the Global LEI System is the only system that establishes a recognized, monitored and standardized global identity for legal entities, linked to the entity’s national ID system. Its universality across borders, combined with open and online access to annually verified business card information linked to each LEI, makes it uniquely placed to enable efficient information exchange between the ‘obliged parties’ defined in the AML/CFT proposal and all competent authorities.

And while this is the first time the LEI has been officially endorsed by the EC in its AML/CFT framework, the LEI has a long track record as a powerful tool in assisting the efforts of financial institutions to combat money laundering and terrorist funding. The LEI enables financial institutions to conduct fully automated, straight-through processing; by replacing outdated manual checks, the LEI increases both the speed and the effectiveness of client onboarding and ongoing compliance checks. This includes improving screening against sanctions and watch lists thereby enabling new efficiencies for both institution and client, lowering costs significantly.

The latest recommendation from the EC that the LEI is used, where available, for customer identification and verification in AML/CTF legislative reforms, has the potential to drastically increase the transparency of legal entities participating in financial transactions. Recent AML scandals have shown that financial criminals mostly operate through a network across borders to conceal their illicit transactions. The LEI, a global standard for unique legal entity identification, can make these connections and transactions across borders visible and easy-to-interpret to the financial institutions and Financial Intelligence Units. It can therefore contribute to the stronger authentication of entity clients, promote transparency and reduce illicit transactions.

By including the LEI in its AML/CFT legislative package, the EC strengthens efforts across Europe to use and reinforce global standards in the promotion of transparency and financial stability. The European Central Bank (ECB) recently recognized the benefits of extending LEI use to cover all future public reporting and financial transactions. As a result, the European Systemic Risk Board has recommended the establishment of an EU legislative framework for systemic and comprehensive adoption of LEIs across the EU by any organization involved in a financial transaction and to identify entities reporting financial information.

In context of the AML/CFT proposals, for those ‘obliged entities’ that want to surpass transparency goals, becoming a Validation Agent offers a vast array of business benefits. The Validation Agent role was created by GLEIF within the Global LEI System to simplify LEI issuance for clients and to deliver a variety of cost, efficiency and customer experience benefits for the Validation Agents organizations themselves. More information on the Validation Agent role can be found on the GLEIF website.

How has the LEI Been Referenced Within the EC’s AML/CFT Legislative Package?

AML / CFT Regulation
As defined in Article 1, this proposal lays down rules concerning:

  • Measures to be applied by obliged entities to prevent money laundering and terrorist financing;
  • Beneficial ownership transparency requirements for legal entities and arrangements;
  • Measures to limit the misues of bearer instruments.

Obliged entities are defined fully in Article 3 of the proposal, but include (with certain exceptions): credit institutions; financial institutions; and various natural and legal persons acting in a professional capacity, ranging from auditors, accountants and tax advisors to legal representatives involved in certain types of transactions, including property, precious metals and stones, gambling services, crypto-asset service providers and crowdfunding service providers.

Reference to the LEI is made in Article 18, which is titled ‘Identification and Verification of the Customer’s Identity’. The text makes clear that where available, an LEI should be obtained by obliged entities, in order to identify a legal entity customer.

Revision of the 2015 Regulation on Transfer of Funds
In a press release announcing the legislative package, the EC makes it clear that primary drivers for enhancements to the existing EU AML/CFT framework are “new and emerging challenges linked to technical innovation.” It names virtual currencies, more integrated financial flows in the Single Market and the global nature of terrorist organisations among these challenges.

The key focus of this Revision of the 2015 Regulation on Transfer of Funds ensures that EU AML/ CFT rules are extended beyond their current remit, to fully apply to the crypto sector. This will ensure full traceability of crypto-asset transfers and allow the prevention and detection of their potential use for money laundering or terrorism financing.

Against this backdrop, the LEI has been referenced twice within the package of legislatory proposals.

  • In section (25), which outlines that transfers of funds or crypto-assets from the Union to outside the Union should carry complete information on the payer and payee, a new requirement has been introduced: “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 Organisation for Standardisation for electronic data interchange between financial institutions.”
  • In a later section that outlines the obligations on the payment service provider of the payer, Article 4 of the Revision proposal sets out the requirements for information that must accompany transfers of funds. In the latest revision, a new requirement for the payer’s current LEI has been added, “subject to the existence of the necessary field in the relevant payments message format, and where provided by the payer to the payer’s payment service provider….”.
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About the author:

Stephan Wolf is the CEO of the Global Legal Entity Identifier Foundation (GLEIF). Between January 2017 and June 2020, Mr. Wolf was Co-convener of the International Organization for Standardization Technical Committee 68 FinTech Technical Advisory Group (ISO TC 68 FinTech TAG). In January 2017, Mr. Wolf was named one of the Top 100 Leaders in Identity by One World Identity. He has extensive experience in establishing data operations and global implementation strategy. He has led the advancement of key business and product development strategies throughout his career. Mr. Wolf co-founded IS Innovative Software GmbH in 1989 and served first as its managing director. He was later named spokesman of the executive board of its successor IS.Teledata AG. This company ultimately became part of Interactive Data Corporation where Mr. Wolf held the role of CTO. Mr. Wolf holds a university degree in business administration from J. W. Goethe University, Frankfurt am Main.

Tags for this article:
Compliance, Global Legal Entity Identifier Foundation (GLEIF), Regulation, Policy Requirements, Risk Management, LEI News