Last week, I was at the Singapore FinTech Festival, and I was struck by how new technologies are being applied to solve challenges in the retail banking and payments space. Digital solutions have been so successful that they are really reshaping how banking is done. It’s a very different story in the derivatives markets, where an ageing infrastructure has hampered efforts to automate at scale. We need to think bigger and we need to move faster.
Earlier this year, ISDA ran a series of surveys on post-trade issues, which highlighted multiple inefficiencies and blockages. Our survey on collateral, for example, found that processes are still lacking in automation, and are resource heavy and subject to operational risk. This is ineffective and it’s costly – we need to get to a point where we can fully digitize and automate the post-trade process.
The answer isn’t to invest in new technology in isolation, however – change needs to occur first at the infrastructure level. As it stands, the framework we use for derivatives trading has changed very little since the 1980s. Agreements are negotiated and documented in paper form. Fax machines are still used for collateral exchange. Firms still use their own terminologies for trade events and actions, meaning constant cross-checking and reconciliation is required on every trade.
For technology to be effective and scalable in the derivatives market, we first need standardization. The ISDA Common Domain Model (CDM) is an important part of that. By establishing a standard set of digital representations for events and processes, the CDM cuts down on the need to constantly cross-check and reconcile trade information, and enables firms to develop automated solutions that can be interoperable and scalable. It also promotes greater transparency and alignment between regulators and market participants, improving the integrity of regulatory data and removing regulatory and interpretation risk.
We’ve already seen how this can work for regulatory reporting. Earlier this year, the CDM was deployed by the UK Financial Conduct Authority, the Bank of England and certain financial institutions in a digital regulatory reporting pilot to explore how technology could help firms meet their derivatives reporting requirements and improve the quality of the information reported. Watch this space: a number major infrastructure providers and technology vendors are looking to use the CDM to help solve some of the biggest challenges the industry faces, including in other asset classes.
Another important initiative is to bring greater standardization to legal documentation. For example, ISDA has developed a taxonomy and clause library related to the ISDA Master Agreement. We recognize that market participants will always need to negotiate bespoke terms, but this work will introduce greater standardization in the way firms negotiate and agree certain contractual terms, increasing efficiency in contract negotiation and enabling use of technology to capture structured legal data.
For an example of how standardization leads to digitization, look no further than ISDA Create. Having developed a new set of standardized initial margin (IM) documents for phases four and five of the IM regulations, we launched ISDA Create earlier this year – an online tool that automates the process of producing, agreeing and executing documentation. We started with IM documentation, but we have plans to extend the platform to the Master Agreement next.
Automation could transform the derivatives market. By creating greater standardization, integrating those standards into digital definitions and documents, and developing mutualized solutions that build on those standards and are widely available to market participants, we will be able to make the most of the opportunities that lie ahead.
Interested in how technology can be used in the derivatives markets and the potential for smart contracts? Come along to the Legal Technology and the Future of Derivatives event in New York on November 20
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