Monday, October 24, 2016

ISDA Says it's Time to Revamp the Derivatives Markets

The fast pace and broad scope of new regulation are driving participants in the complex derivatives markets to adapt quickly. Layers of old infrastructure and practices built up over time need to be overhauled to keep up with new regulation, technological change, and overall structural changes in derivatives markets.  In a September 15, 2016 white paper, the International Swaps and Derivatives Association, Inc. (ISDA) has called for greater standardization and automation of derivatives trade processes in order to improve efficiency, reduce complexity, and lower costs for market participants.  According to ISDA’s chief executive Scott O’Malia, "More recently, the sheer pace of regulatory change has meant firms have been under pressure to tackle the next pressing deadline. The result is a derivatives infrastructure that is duplicative and based on incompatible operating standards, and this isn’t sustainable.”  The white paper identifies a number of ways the ISDA proposes to automate and streamline the significant reporting, trading, clearing and collateral management requirements that have emerged as a result of regulatory changes. In addition, the paper highlights areas where greater standardization and investments in technology, like blockchain, can make traded processing faster, more efficient, and more cost-effective at all stages of derivatives trading.

 

Post-crisis reforms to the derivatives markets have resulted in greater safety and transparency.  But these reforms have come at some cost, which is driving some unintended consequences.  According to the white paper, “The increased cost of supporting traditional post-trade activities and complying with new regulatory obligations, alongside reduced profit margins in many areas of the derivatives business, is not sustainable. Industry participants need to find new ways of operating.”  The purpose of this paper, according to ISDA, is to help the industry develop a common understanding of what the derivatives industry needs to cut costs and stay in business. To this end, ISDA proposes cutting complexity and working to reduce inefficiencies by standardizing data reporting, documentation, and business processes. They also propose leveraging technological advances like cloud services and distributed ledger applications, including self-executing smart contracts and employing blockchain processes.

 

Standardization

 

ISDA proposes greater standardization of data, documentation, and processes, seeing these as ways to drive down costs of trading. Employing globally consistent product identifiers and trade identifiers, would facilitate regulatory reporting and harmonization, make it easier to aggregate derivatives trade data across borders, and make trade confirmation, reconciliation, and compression much more efficient.  ISDA has long been a proponent of standardized trade documentation. Such standardization creates efficiencies in negotiation and clearing and helps to ensure that contract terms keep pace with regulatory changes.  ISDA’s white paper singles out collateral management as an area with opportunities for more efficiencies from greater standardization.  “Among these are opportunities for the development of standard account control agreements, publication of eligible collateral matrices, netting of swap obligations with collateral cash flows and segregation account standards for bilateral margin. ”

 

Technology

 

ISDA urges the industry to embrace new financial technologies, or “fintech," as they feel that it would not only drive down trading costs by making them more automatic and efficient, but would also streamline standardization, aiding compliance and regulatory reporting. ISDA touts blockchain or distributed ledger technology (DLT) as ways to increase trade efficiency. They also say that the industry should look into smart contracts for potential further application, building on the ISDA’s existing and ongoing work on standard forms of documentation, including definitional booklets and confirmation templates. Smart contracts could also be useful in eliminating redundant reconciliation processes and give regulators access to an accurate and up-to-date instance of a transaction at any time.  

 

Moving Forward

 

ISDA sees this white paper as a starting point for the industry to agree on common objectives. In the short term, however, ISDA identified a list of goals it would like to accomplish by the end of 2016, including:

  • assess post-trade infrastructure, identifying inefficiencies, and developing near-term solutions;
  • coordinate the development of a plan for the creation of common domain models; and
  • work with industry stakeholders to identify a venue to create an open-source repository or repositories for required artifacts. Stakeholders should agree to and circulate a roadmap for these repositories, roles and responsibilities and basic principles.

 

 

The full text of "The Future of Derivatives Processing and Market Infrastructure” is available via: http://www2.isda.org/attachment/ODcwMA==/Infrastructure%20white%20paper.pdf


 

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