Earlier today, the International Swaps and Derivatives Association (ISDA) sponsored a webinar, “The Foundations of an Efficient Market Infrastructure,” that focused on an initiative by ISDA’s Market Infrastructure and Technology Committee to facilitate the adoption of emerging technologies (DLT, smart contracts)into the trading, documentation and processing of derivatives.

The focus of the conference was on derivatives processing and reporting; however, the issues that plague derivatives are relevant to many other financial market processes and activities.  Specifically, the primary challenge with respect to derivatives – a strained infrastructure that is too costly and inefficient to be sustainable – is common throughout the financial markets.  Or, put  differently, the development of technological solutions within the derivatives sector has the potential to become a template for the resolution of similar issues in other sectors of the financial marketplace.  For this reason, today’s webinar may have an appeal that is broader than market participants with an interest in the process of derivatives.

The remainder of this message contains a summary of the information discussed at this informative webinar.

The existing market infrastructure for derivatives processing is largely built upon:

  • The documentation architecture published by ISDA (master agreements, confirmations, product specific definitional booklets, etc.); and
  • Various operating systems and processes that were built in response to regulatory mandates flowing from the 2009 G-20 Summit in Pittsburgh.

The strain on existing infrastructures from costs operational inefficiencies is not sustainable.

Distributed ledger technology (“DLT”) and smart contract technology (“SCT”) presents a compelling and unique technological solution to alleviate this strain.  The successful use of DLT and SCT in connection with derivatives processing requires the mutualization of technology and operational processes among financial institutions, end users and regulators.  However, any such mutualization process will necessitate a change to the models of market infrastructure.

The current model is to build solutions into the existing infrastructure.  For example, ISDA would develop a new definitional booklet to address trading in a new asset class.  Similarly, in many cases, each financial institution would build its own “bespoke” technology solutions to address new regulatory requirements, such as Dodd-Frank requirements in the U.S. relating to trade compression, portfolio reconciliation and reporting.  The new model will be to use DLT and SCT to overhaul the market infrastructure, so that all parties are working from a common, shared platform of data and information.

The first step in this process is the development of standardized data processing, which ISDA refers to as a “Common Domain Model” or CDM.  In essence, CDM contains the information about events and data structures that will eventually be enforced through SCT. For additional information regarding the CDM initiative, please see the ISDA publication entitled “Unlocking Value via Process Standards,” which is available here.  In addition, on September 27th, ISDA will be hosting a conference in London that will focus on the emerging roles of DLT and SCT in the processing of derivatives with specific attention given to legal issues in respect thereto.  The Agenda for that conference is available here.

Good day.  Good to know? DR2