Tuesday, September 20, 2016

Standardize derivatives infrastructure and leverage tech, ISDA urges

By Lene Powell, J.D.

The derivatives industry has done a good job of meeting tight deadlines for changing regulatory requirements, but in the process has built up a complex web of non-standard systems that some are nervous may not be robust in times of market stress, said the International Swaps and Derivatives Association (ISDA) in a new white paper. ISDA urged industry participants to work to reduce inefficiencies by standardizing data reporting, documentation, and business processes. Technological advances like cloud services and distributed ledger applications, including smart contracts, can also help drive efficiencies, said ISDA.

“Our members are looking for more effective, less costly and less complex processes, using technology where possible to cut down on manual processes,” said Scott O’Malia, ISDA’s CEO and a former CFTC commissioner. “ISDA is helping to respond to these issues, and our whitepaper highlights a number of areas where the Association can work with the industry and regulators to improve trade processing through the lifecycle.”

Standardize data. It is critical to standardize data standards, including data representation, naming conventions and formats, as well as globally consistent product identifiers and trade identifiers, said ISDA. In particular, a consistent global product identifier would facilitate regulatory reporting and harmonization and make it easier to aggregate derivatives trade data across borders.

A consistent product identifier could also be put to other uses, including product categorization for regulatory purposes and various post-trade activities including trade confirmation, reconciliation and compression. ISDA has published a paper identifying key principles for the construction of global product identifiers. Other areas of focus include standard naming conventions and associated definitions for package transactions, as well as trade identifiers that are globally unique to a specific transaction.

Standardize documentation. With documentation having historically been negotiated on a bespoke basis, legacy clauses may no longer be appropriate in the changing regulatory environment, ISDA noted. The association can help the industry work toward appropriate levels of standardization and incorporate these into new versions of relationship documentation. Even agreeing to restrict negotiation of these documents to certain standard elections could be a big step forward, ISDA observed. Solutions could be developed to help market participants electronically agree and store information upfront in an easily accessible form.

Standardize processes. Industry should collectively agree on and collaborate to define the most efficient market operating models, then technically encode them as common domain models (or CDMs) that systematically reflect how the market operates, said ISDA. CDMs would only be successful if they are used to drive trade execution, not just for reporting, and would need to be interoperable with existing standards.

Leverage technology. According to ISDA, the regulatory and industry communities would benefit from collectively developing a RegTech strategy, referring to common technical artefacts including software and standards that provide mutual benefit to both regulators and market participants in complying with regulations. Common regulatory eligibility models that effectively encode a consistent interpretation of rule eligibility would generate reference data that could be used by other infrastructures like trading platforms, subject to appropriate permission, to assist routing of transactions through the process. This would be particularly helpful in MIFID II reporting, for example, as the main technology challenge with MIFID II reporting requirements relates to interpretation of data.

In addition, emerging FinTech solutions could drive efficiencies and reduce costs. Regulators are taking an interest in blockchain or distributed ledger technology (DLT), and a number of DLT providers have developed and successfully completed test use cases for derivatives transactions. Smart contracts are a potential further application and could build on work already done by ISDA to develop standard forms of documentation, including definitional booklets and confirmation templates, in conjunction with FpML, said ISDA.

As a precursor or alternative to smart contracts, the industry could develop a processing model that operates on the basis of a single representation of a transaction, or “Golden Record.” Such a record could eliminate the need for many duplicative reconciliation processes and allow market participants and regulators to access an accurate and up-to-date instance of a transaction at any time, ISDA explained.

Next steps. As a first step, the industry needs to agree on common objectives, whether that be short-term solutions to current infrastructure challenges or longer-term objectives associated with process redesign, ISDA said. This effort will be led by ISDA’s Market Infrastructure and Technology Oversight Committee (MITOC).

ISDA identified a number of steps 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 artefacts. Stakeholders should agree to and circulate a roadmap for these repositories, roles and responsibilities and basic principles.