06 October 2020

ISDA: An Opportunity for Standardization

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

Financial institutions across the world are searching for ways to overcome squeezed margins by improving efficiency and reducing costs. As a trade association, ISDA’s driving motivation has been to help our members achieve that goal, and we’ve developed various mutualized solutions that do just that. But we think there is an opportunity to go further – by creating greater alignment and standardization between derivatives and securities financing transaction (SFT) markets.

In a paper published this week, we kicked off what we hope will be a constructive discussion across the industry about the practicality of closer collaboration and improved consistency between derivatives and SFT markets. That paper sets out the benefits and challenges of achieving this, and identifies specific areas where we think increased harmonization will create cost savings and improved operational, collateral and capital efficiencies.

You might ask why we think now is the time to have this conversation. The answer lies partly in the current push by financial institutions to spot opportunities where they can centralize and optimize pre- and post-trade operations to reduce costs. The other driver is the increasing shift to digitization and automation, which will require common standards, terms and documentation in order to be effective and scalable across markets.

There are a number of areas where greater standardization could be achieved. The first is to leverage the existing overlap in terminology to create a common set of definitions, and to document derivatives and SFTs under a single master agreement. This would cut down on duplication and complexity, and mean firms could program their systems to reflect one consistent set of documents and definitions rather than several similar but not identical ones.

This approach would also expand netting sets, potentially enabling institutions to reduce credit risk and optimize their use of collateral, thereby lowering funding costs. As a further benefit, firms could commission a single set of legal opinions on close-out netting, rather than sourcing several for each jurisdiction. This alone would unlock significant savings for the industry.

As well as documentation advantages, greater standardization between derivatives and SFTs would enable the creation of solutions to allow firms to implement legal, regulatory or market practice changes on a consistent basis across these markets.

Take benchmark reform as an example. ISDA is close to publishing a protocol to allow firms to efficiently amend existing agreements with other adhering parties to include new fallbacks for trades that reference key interbank offered rates. That particular protocol is intended to cover SFTs as well as derivatives, but that’s more the exception than the rule due to the complexities of creating amendments that work for multiple different documents. Imagine the efficiencies that could be achieved if future amendments of this type could be applied holistically and seamlessly on a cross-industry basis.

Standardization is also a prerequisite for digitization. Working together to develop common standards and taxonomies – for instance, through the Common Domain Model – would help facilitate automation and interoperability between derivatives and SFT markets, enabling technologies to be applied at scale across multiple markets.

We recognize this proposal comes with challenges – there are a number of areas, for instance, where specificity of product terms is absolutely necessary in order to preserve the unique characteristics of each market. However, we think that, by working together, many of the technical issues can be resolved. In particular, we would like to work in a collaborative manner with other trade associations to achieve the alignment in derivatives and SFT documentation, opinions and taxonomies.

Change is never easy – and there’s no doubt this would disturb the status quo and alter existing behaviors and practices. However, we think the current trend towards increased digitization and the push by financial institutions to improve operational and capital efficiency means we have to start talking about the benefits that alternative structures could bring.

In 1997, Apple told computer users to ‘think different’ when it launched the new Mac. In order to realize the maximum efficiencies for our members, it’s time we did the same.

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