There’s a lot we take for granted in the derivatives space. The fact there’s a common language, for example – an agreed set of definitions and standard terms everyone can agree on. This means there’s a common foundation for negotiating trades, whatever the product and whatever the jurisdiction. But it wasn’t always like this, and it certainly wasn’t inevitable we’d get to this point.
Look back to the early 1980s, and the derivatives market was very different. Then in its infancy, each deal involved weeks and weeks of tortuous negotiations to agree terms. This was because each bank had developed its own contract, each with its own unique terms and definitions – something frustrated lawyers referred to as multiple agreement disorder, or MAD.
ISDA was established in response to this mess, and the result was the ISDA Master Agreement, a standard document that essentially removed the shackles from the derivatives market and set it on its path of growth. That was 30 years ago this month – an anniversary we celebrated with those who helped create the Master Agreement at Middle Temple Hall in London last night. Thirty years on, the Master Agreement is still as important as it was in 1987, and it stands as a perfect example of the industry cooperating to create something flexible, comprehensive and durable.
Jump to 2017, and the industry faces a new set of challenges that are equally as significant. Market participants now face a complex web of execution and post-trade management processes, largely as a result of regulatory change. Managing a trade through its lifecycle has become resource-intensive and costly as a result.
New technology – smart contracts and distributed ledger systems, in particular – offers the chance to mitigate these inefficiencies. The potential is enormous, but, as with the derivatives markets 30 years ago, the foundations need to be right. That means coming up with standard definitions and processes, and building the structure on a strong legal framework.
Just as with the development of the Master Agreement, ISDA is the perfect place for this to happen. We’ve already started work on this, and published a white paper last year on the future direction of derivatives processing and market infrastructure.
There is plenty of work to be done on smart contracts. We need to bring technology partners and members together to create the appropriate balance of automatable and enforceable agreements. Some of the most fundamental challenges include how to represent contractual obligations in a standard code using well-defined processes and definitions, and anticipating and developing the means to redress extraordinary events of a discretionary nature during the lifecycle of a trade. The territory between automated processes and those requiring human intervention will need to be clearly defined.
We’ve been restructuring our working groups to start discussing these issues. The work on smart contracts, process automation and a consistent data taxonomy is in the early stages. But it’s an incredibly exciting place to be. And, just with the publication of the Master Agreement 30 years ago, it could be transformational for the derivatives market.
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