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The Promised Land- an introduction

As a profession, lawyers are perhaps not best known for their eager embrace of new technology. The cynically-minded may say such reticence does not extend to the pursuit of money. The advent of new technologies, credibly promising substantial savings, will put these previously compatible stereotypes to the test. Over the last few years, ISDA and its associated partners and working groups have been working on three parallel, but complementary, initiatives- the ISDA Clause Library, the Common Domain Model and ISDA Create. As standalone projects, each offers increased efficiency via standardisation; taken together, they lay the foundations for the transformation of financial transaction documentation.

ISDA Clause Library

The ISDA MA began life as a standard format, its near-universal acceptance imposing a uniform structure on bespoke, and therefore expensive contracts. If the ISDA MA is the derivatives documentation Bible, the Clause Library (“the Library”) aims to be the King James Authorised Version. Simple in concept, though challenging in conception, the Library provides uniformly drafted clauses for frequently negotiated provisions and their most common variants. As of now, the Library covers the 1992 and 2002 ISDA MA under English, New York, Irish and French law and work to cover VM CSAs under these jurisdictions, as well as Japanese law, is materially complete. A clause is defined as to purpose e.g. Automatic Early Termination, accompanied by a set of standard drafting options delineated by business outcome. A standardised format will become a standardised form, composed of lego-like legal building blocks. Each block may contain the following variables:

  • The ISDA MA version- 1992 or 2002;
  • Clause Topic- the subject matter of the clause e.g. Cross-default
  • Standard Clause- the standard drafting to perform the Clause Topic, this can be varied by:
    • Drafting Variant- sorted by business outcome
    • Allowable Value- required data for the operation of the clause
  • Variant Clause- a version of the clause intended to perform a specific business outcome

Widespread adoption of the Library’s taxonomy and standard provisions will substantially decrease the time and expertise required for initial contract negotiation. Further application to legacy contracts will allow for the outcome-based categorisation of legal agreement data, tracking key terms that impact vital business and operational functions. The increased accuracy and consistency afforded by standardisation will substantially reduce the time and effort involved in regulatory or market-driven repapering exercises, a large part of which typically involves creating a “clean” initial data set. The Library is not intended to eliminate all negotiation or disallow bespoke provisions, but its application will substantially decrease their occurrence, significantly reducing costs while conferring legal consistency, focussing expensive attention on substantive issues rather than drafting preferences.

The potential benefits are both clear and potent, but in the absence of widespread adoption, they will only remain as potential. Free for use by both members and non-members, the use of the Library for new contracts would seem relatively uncontroversial on paper; in practice lawyers may prove resistant to “de-lawyering”. The more substantive benefits of the Library arise from its application to legacy contracts, this would be a repapering exercise which would dwarf any previous project. Despite the Library’s clearly laudable and commercially-desirable aims, as a single initiative it is likely that the benefits conferred are outweighed by the initial costs in time and resource. However, the truly transformative potential of the Library lies in its convergence with “sister” initiatives to facilitate complete digitalisation.

Common Domain Model

While the Library offers a standard set of terms to document the legal obligations of a trade, the Common Domain Model aims to standardise and digitalise the record of the trade and subsequent events and actions. Straight through processing (“STP”) has long been the holy grail of operations departments, but it remains an elusive quest. Although success has been achieved in messaging e.g. SWIFT for payments and Acadiasoft for margin collateral transfer, the initial promise of 1999’s Financial Products Mark-Up Language (“FpML”) has descended into a financial reporting Tower of Babel. The multiplicity of systems and different data models across a single enterprise is mirrored across counterparties. Every transaction is replicated across multiple datasets, each addition to which has to be multiple reconciled both internally and externally. With the onset of MiFID 2, a typical (cleared) trade may be reported by and to the following entities: Dealer> Execution Venue> Middleware> Dealer> CCP> Trade Repository> Regulator. The same trade will have to be reported to the various actors at a number of stages pre- and post:  setup, pricing, execution, capture, allocation, confirmation, regulatory reporting, clearing, settlement, risk calculation, and ensuing life-cycle events. At each intersection of entity and event, a different descriptor may be required to denote the same trade, each reconciled with the other and to the underlying reality.

The CDM takes a radical approach, upending traditional taxonomic hierarchy. Rather than beginning with the product eg.  a descriptor for semi-semi GBP 5yr IRS, the CDM begins at the “event” stage. An event represents an action that may be applicable to any trade e.g. initiating the trade, cancelling, amending, novating etc. The few first stage events identify actions which are independent of agreed contractual terms. The second layer of the picture denotes “Dependent Events” defined by contract eg. floating rate observation, record of daily value, option exercise. A simple FX trade is therefore described as an event- the exchange of cash between two parties, price is captured by the two amounts exchanged. A bond sale is denoted by distinct records- the cashflows that represent the bond “definition”- principal out, principal in, coupon- the transfer records of the bond as defined and the cash purchase amount. Beginning with events rather than products or elements thereof, one can quickly build a record of more complex transactions- simple derivatives are built from independent and dependent events, complex derivatives are built from previously-defined simpler derivatives. The process scales up to whole portfolios, allowing for the automatic operation of portfolio events such as collateral calls, capital and risk calculations.

Similar to the Library, the CDM is freely accessible to all, its benefits are clear and they outweigh any competitive advantage in maintaining a proprietary data model/template. However, once again the advantages follow a network effect, multiplying with widespread use. Just as the first fax machine was prohibitively expensive, useless until the second came along and very useful by the time the considerably cheaper millionth machine arrived, utility depends entirely on widespread adoption. In the case of the CDM, costs will not reduce as adoption multiplies, its use will require enterprise-wide rewiring of infrastructure, and return on investment will only occur if the model achieves commonality. While the Library offers immediate “reference” benefits as at no cost in respect of new transactions, the CDM will require significant outlay. The Augean Stables of legacy systems at many enterprises is long overdue an extensive clean-out, there are enterprises which would benefit from unilateral adoption. However, as a standalone project and in the absence of a regulatory Hercules, it is difficult to see firms acting mainly on faith.

ISDA Create

The third foundation of the digital derivatives documentation future is the ISDA Create platform. Developed jointly with Linklaters, the platform’s first iteration aims to facilitate the negotiation and data upload of IM documentation. Sold to dealers, but free to the buyside, ISDA Create has already seen off its nascent competition MarginXchange. ISDA Create aims to replicate the traditional process of negotiation by email exchange with added oversight, granular deployment of responsibilities and auditing/recordkeeping functions. For those who use it, its initial utility will be in the upload of legal data to downstream systems. This was a significant bottleneck in earlier VM projects, and is likely to be replicated in the increased volumes of IM phases 5 and 6. The recent addition of the custody function is welcome and will increase efficiencies in a time-critical area by signalling certain issues as non-negotiable. As the first “foundation” to go live, ISDA Create has had a good start with approximately 50 active users and 160 firms in testing. The platform is essentially an IM horse at the gates of derivative documentation’s Troy. If ISDA/Linklaters can achieve widespread acceptance for IM, the platform will become the de facto standard for the whole range of ISDA documents and beyond. Its immediate utility for IM and its replication of traditional negotiation processes, combined with enhanced audit and upload facilities, represent an ideal entry into the (possibly) cluttered desk/mindspace of the derivatives lawyer.

Not “just” the ISDA

It should be noted that elements of above are in the process of being extended to Repo/ Stock Lending. ISLA and ISDA have agreed to increase and expand electronic contract opinions and to apply the CDM to facilitate greater automation across both derivatives and securities financing markets

Smart Contracts

The Index Cessation Event is one of three statements:

In summary, we have:

  • The Library- useful for new contracts and likely to gain traction over time, but unlikely to justify wide scale legacy repapering as a standalone project
  • The CDM- a solution in answer to a pressing problem, but the high cost of initial investment will deter unilateral adoption, perhaps impeding multi-lateral adoption
  • ISDA Create- an existing platform of limited current utility, but capable of expansion to a panoply of other products

Each is a highly innovative, long awaited necessary project in its own right. The standardisation of legacy contract terms would be the first step in measuring legal risk within CRR terms. A truly common domain model would massively reduce reconciliation, reporting and regulatory burdens. With the exception of ISDA Create, the only port in the oncoming IM storm, each project on its own is unlikely to overcome the existing intransigence/lack of resource and requirement for significant investment.  However, each element is a necessary foundation for STP from initial negotiation to recording of the trade and life cycle event. These elements are a precursor to the automation of events and payments as part of a smart contract.

What is a “smart” contract?

There has been some understandable confusion over the term. Certainly not “smart” in an AI sense or a “contract” in a strictly legal sense, a smart contract is a chimera of the two-

“A smart contract is an automatable and enforceable agreement. Automatable by computer, although some parts may require human input and control. Enforceable either by legal enforcement of rights and obligations or via tamper-proof execution of computer code.”[1] Fundamental questions remain as to the initial model of a smart contract- is it essentially a traditional ISDA with coded operational conditions added, or does the code form part of the contract itself? To what extent is Distributed Ledger Technology involved? If so, to what extent is its distribution? The answers to these and other questions will be evolved. It is clear that there are operational clauses in derivatives and other financial contracts that can be devolved to conditional, “codeable” logic e.g. X amount is payable on a certain date as calculation of an observed floating rate adjusted by a day count fraction. Non-operational clauses such as: governing law, jurisdiction, entire agreement etc. lie on a spectrum of “code-ability”.

A persistent background of low short term rates and flattened yield curves combined with increased regulation and capital requirements, has long mandated that the easiest way for banks to “make” money has been for them to save it. The industry has generally failed in this regard. Despite large-scale reductions in head count, physical relocation to north- near- and offshore, across the board costs remain stubbornly fixed at 70-75% of turnover. Enterprise-wide cost reductions have been subsumed by increases in compliance and reporting costs, even without factoring in the fines for failures in these regards. Smart contracts offer the opportunity to slash legal and operational costs by 50% or more (obviously estimated). ISDA has released a number of white papers detailing Legal Guidelines for smart contracts in respect of the main transaction types- as with the foundations- attention has been primarily focussed on interest rate derivatives as the largest and “simplest” market. Aside from the wholly new transaction types which smart contracts may make possible, they promise the sunlit uplands of radical cost reduction via true STP from trade to termination. Reconciliations will be redundant, payments, life-cycle events and terminations for cause will be automated.

[1] Clack, C., Bakshi, V. & Braine, L. (2016, revised March 2017). Smart Contract Templates: foundations, design landscape and research directions


Smart contracts are possible and entirely desirable commercially, the question is whether they are likely. The use case for each of the foundations is compelling but not compulsive; in combination they should be compulsory. However, there is no centralised agent capable or willing to compel the necessary change. The industry as a whole is struggling with increasing compliance costs and lagging far behind regulatory reporting minima- the chance should be seized to write the agenda rather than have one imposed. ISDA has done a remarkable job in laying the building blocks for a long overdue revolution in operational systems and documentation.

Given the short-term pressures currently pressing- Covid resource-strain, IBOR amendment, CSDR and IM Phase 5 and 6, it is unlikely that market-wide resources will be devoted to this diffuse, but wholly worthwhile set of projects.

There have been a number of religious references in this article- the Promised Land requires a degree of faith. This is the future and it’s coming- but probably not for a while. 

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