Who wants to see digitalisation of legal contracts? Well certainly the derivatives contingent of the financial services industry which is battling increasingly complex standard documentation, streams of regulatory re-papering projects, and the continuous need to put in place age-old favourites such as the ISDA Master Agreement. Let’s focus on the ISDA Master Agreement, the hugely successful framework document underpinning most OTC derivatives trading.
The first version of the ISDA Master Agreement came out in 1987, with updates following in 1992 and 2002. It has a standard body of terms, which are amended in a schedule, following negotiations. Thousands of these negotiations take place every year. They require specialised legal negotiation teams, often split across continents, with regular outsourcing to law firms and alternative legal services providers.
Consequently, banks and the master agreement’s other frequent users are on the lookout for innovative ways to cut ISDA documentation’s associated costs. Nothing could be more welcome than a “killer application” digital tool to alleviate the documentation burden.
On 21 January 2021 ISDA and its counsel made a significant stride towards that goal. The ISDA Master Agreement was made available for negotiation digitally via ISDA Create, an online platform that is currently mainly used for initial margin documentation.
To become a ‘one-stop’ solution for ISDA Master Agreements for the entire market, ISDA Create needs to provide efficient solutions in three main areas: (i) streamlining the ISDA Master Agreement negotiation process; (ii) providing reliable contract data that can be plumbed into an institution’s infrastructure for day-to-day payments, settlements and collateral transfers and (iii) accurately reflecting the parties’ rights and obligations in case of defaults or market turbulence. Each of these three areas comes with its own challenges.
Arguably, the negotiation component is the easiest for banks to adopt and implement. The ISDA Create negotiation tool has the look and feel of a Word document enhanced with clever tracking, approval plug-ins and, most importantly, armed with ISDA Clause Library fall backs. These fall backs provide market standard alternative wording for ISDA clauses, so that, for instance, instead of countless different variations of the innocuous ‘Rounding’ provision, there are two or three alternatives that capture the main options used in the market, which are well-worded and formulated. A clear audit trail of all edits and approvals is also provided.
We understand from our bank clients that there are also no major technical obstacles to adopting the platform for the negotiation of the less complex ‘vanilla’ agreements (once negotiators and approvers are trained).
With client specific templates that have been built over the years and have bespoke approval processes, things can be trickier and it may take time until parties have enough confidence to use ISDA Create for such agreements. However, these negotiations should be fewer in numbers. It is also possible that even when there is widespread market acceptance of the platform, some custom-built agreements never migrate and stay on paper.
Despite these advantages, our conversations with our banking clients indicate the biggest challenge for the platform to gain momentum will be buy-side client preference. If a sufficient number of clients request or acquiesce to digital negotiations, the task is easy, conversely, if there is no client demand or worse resistance, the take-up of ISDA Create will be slower: a charm offensive will be needed, building on ISDA Create’s previous great outreach work.
Many buy-side clients do not have the same regulatory obligations, documentation volumes and associated challenges as the sell-side and, as a result, for some smaller firms the rationale for digitalising, as opposed to the traditional exchange and negotiation of documents by e-mail, may not be as strong. It should be: streamlined negotiations, and storage of documents in a single repository, should be appealing to smaller buy-side entities too.
In relation to generating reliable contract data, banks and less-heavy derivatives users alike have much to gain from automating contract data flow into their trading and collateral management systems. Extracting good quality data from paper ISDA Master Agreements, and putting these inputs into financial infrastructure can be a challenge for many of the largest market participants. Some firms have been developing, often expensive, in-house systems to address these gaps. However, we are not aware of any system which has ISDA Create’s market standard negotiating front and direct data flows from agreed contracts, and if there is it will have required substantial investment.
The advantages of clear, structured and accessible data, particularly from a risk management perspective, cannot be overestimated. Of course, there are roadblocks. Connecting trading and collateral management infrastructure to a new external data source requires time and resources and it is well known that some institutions have years of IT projects in the backlog. ISDA Master Agreement data quality might not seem critical when compared to some other pressing regulatory projects and, when banks make the decision to sign up, it might take a time for their budget and capacity planning to catch up.
The technology of ISDA Create could also be applied more broadly to the negotiation and execution of repo and securities lending documentation and ISDA and its counsel are working with the relevant market associations to incorporate their standard documentation into the platform.
If successful, this will add further impetus for the buy and sell sides alike to adopt the platform for their standard form documentation negotiations and data management.
In the meantime, we hope that ISDA Create gets its deserved momentum with the buy-side firms (to whom its service is free). Follow the Long and the Short of It for further developments in the space of digitalisation of derivatives.