Financial market participants around the world share a common goal and a common challenge: to increase margins and profitability by more efficiently deploying capital and other resources while maintaining strong balance sheets.
One of the important ways firms are working towards this is by standardizing and automating processes and functions. These efforts are occurring on an individual basis within institutions. They are also occurring on a collaborative basis across firms, in the form of various industry utilities and trade association initiatives.
ISDA believes an important opportunity exists to further expand these efforts. This paper explains and illustrates how and why two large, important and interconnected markets – derivatives and securities financing transactions (SFTs) – could collaborate to achieve greater standardization and improved efficiency.
Key elements of such an approach would include:
Developing common legal definitions across the derivatives and SFT markets, documenting derivatives and SFTs under a common master agreement and procuring one set of legal opinions in jurisdictions around the world on close-out netting for both derivatives and SFTs.
Implementing consistent solutions across the derivatives and SFT markets that enable market participants to more seamlessly adapt and migrate when key changes (such as the interbank offered rate (IBOR) transition) occur.
Facilitating the digitization of the derivatives and SFT markets, in terms of both negotiating and documenting trades, and developing a consistent trade record for confirmations and reporting, with standardized trade content and formats.
The benefits of such an approach could be significant. These benefits would include increased operating efficiency (by reducing duplicative efforts, scaling legal work and digitizing/automating processes) and potentially reduced credit risk (by facilitating collateral payment netting and expanding close-out netting sets, which could favorably impact firms’ capital).
There are of course significant challenges that market participants would confront on the road to increasing collaboration and standardization across the derivatives and SFT markets. All joint legal work, for example, would need to recognize and preserve the unique characteristics that define products in individual market segments. In addition, transition by a particular market segment to a newly derived definition of a term for use across markets would need to factor in whether and how a legacy book of business can and should be migrated to the new standard, and how that might influence adoption of the new term.
Because of the benefits that increased collaboration and standardization appear to offer, and to assist market participants in considering alignment between derivatives and SFT markets, ISDA has developed this paper.
The first part provides an overview of the repo, stock loan and derivatives markets, discusses their interconnectedness, outlines opportunities for efficiencies and describes the potential benefits of realizing such efficiencies.
The second part sets out a proposal for how this could be achieved. It provides a path for expanding the ISDA Master Agreement so it could be used to document both derivatives and SFTs. It also considers certain key issues that would need to be addressed in such an exercise, and includes a granular analysis of key terms from the different documents to identify specific potential synergies, as well as those key product terms where specificity would need to be maintained.
ISDA hopes this paper will elicit constructive dialogue and analysis among derivatives and SFT market participants on the benefits, challenges and feasibility of a more collaborative and standardized approach in these key financial segments.