Some Thoughts on Noble

Credit events in the credit derivatives market often spark a lot of debate, but the issues relating to a possible restructuring of a Noble loan have been particularly hotly debated by the industry. That’s resulted in plenty of column inches in the media, which is good: it’s important that these events are discussed and deliberated, and the issues are widely broadcast to the broader industry.

On the issue of Noble, however, there are a couple of important facts we think need to be clarified. First, the determinations on whether a credit event has occurred aren’t made by ISDA. They are actually made by industry Determinations Committees (DCs) each comprising 10 sell-side and five buy-side participants. These 15 firms vote on whether a credit event has occurred depending on the publicly available information, the criteria set out in the Credit Derivatives Definitions and the rules on governance set out in the DC rules. ISDA acts as secretary to the DCs and administers the process – we don’t have a vote and we don’t make the decisions.

Saying ISDA makes the decisions is akin to saying ICE Benchmark Administration (IBA) decides what the LIBOR rate should be. After all, it’s now called ICE LIBOR and is published on the IBA website. But IBA administers the process – the actual LIBOR rates are based upon submissions from LIBOR contributor banks.

Second, some of the stories imply that the DC rules failed to provide for the Asia ex-Japan DC’s decision to dismiss. That’s incorrect. As the DC statement of August 10 states, the DC felt it did not have sufficient information to determine the DC question one way or the other, because it was not able to get hold of the underlying loan documentation and details of the guarantee. Market participants crave certainty, and so the lack of public information on the Noble loan and guarantee has created confusion and frustration in the market. The rules do allow the DCs to dismiss a question, which requires an 80% supermajority vote, and provide for the bilateral triggering of contracts in the event a question is dismissed. Now, people can argue that a different outcome would have been preferable, but they can’t argue that the potential for a dismissal isn’t set out in the rules as they stand.

Credit market participants have not had to bilaterally trigger a credit derivatives contract for some time. The complexity, operational risks and potential for disputes that it creates was one of the reasons why the DCs were established in the first place back in 2009. ISDA’s members played an important role in facilitating the determinations framework, and, in our role as secretary, we’ve worked with each of the five regional DCs to improve the transparency and governance of the DC process. There’s likely to be plenty of feedback from market participants on changes that could be made to avoid bilateral triggering exercises in future. ISDA will pull that industry comment together, and will feed it back to the DCs. Where we can lead industry debate and propose solutions, we will. It’s in everyone’s interests for this market to work as safely and efficiently as possible.

 

 

 

VM Rules: Almost There

Six months ago, the industry was facing the possibility of real disruption. With the variation margin ‘big bang’ set for implementation on March 1, but with only a fraction of the necessary changes to documentation completed, there was a very material risk that a large part of the market wouldn’t be able to trade.

Fortunately, regulators across the globe provided forbearance that allowed parties to continue trading under their existing documentation, providing extra time for firms to continue the lengthy and complex process of amending or creating credit support annexes (CSAs) with in-scope counterparties. That extra time was critical, as final national rules had only been published just months earlier in some cases, leaving a very small window for firms to complete what was essentially a colossal repapering exercise.

With the forbearance set to expire in certain jurisdictions, including the US, on September 1, the industry is in a much better position than it was earlier this year. At the end of February, the estimated proportion of required CSA amendments that had been completed stood at one third. That had reached 90% by the week ending August 11. The 60-odd percentage-point increase represents tens of thousands of newly amended CSAs, each requiring hours and hours of complex bilateral negotiations with counterparties to agree the changes.

That doesn’t mean the job is done, and it doesn’t mean the industry is getting complacent. There’s still a tail of mostly smaller firms that needs to be worked through in the coming weeks and months. These include those counterparties that were operationally unable to support the new regulatory compliant terms until recently, or those cases where bilateral negotiations to amend CSAs have been particularly complex. ISDA will continue to monitor progress right through to September 1, and will share those results with regulators.

But there’s little doubt the extra six months was absolutely vital and averted what could have been a big problem on March 1. Regulators deserve credit for addressing the concerns by providing forbearance – and the industry has worked diligently to make the necessary changes during that time.

The question is what happens to those trades executed after March 1, in line with the regulatory forbearance, but where CSAs have not yet been amended? The industry is working on the basis that those trades will need to be unwound if they are not subject to regulatory compliant variation margin CSAs by September 1. Given firms lack a contractual mechanism to unilaterally force their counterparties to unwind, it will take time to negotiate the terminations – but firms want to be able to demonstrate they’ve been working to tackle the issue in advance.

The rollout of the variation margin requirements doesn’t mark the end of the non-cleared margin implementation effort. The European Union (EU) will bring physically settled FX forwards into scope of the non-cleared margin rules from January 3 – the only jurisdiction to do so – which will result in another wave of CSA negotiations. While a small number of so-called phase-two firms will post regulatory initial margin from September 1, a larger number of counterparties are set to follow suit in September 2018, 2019 and 2020. On top of that, ISDA is preparing to launch the next iteration of the ISDA Standard Initial Margin Model – ISDA SIMM 2.0. That goes hand in hand with the successful operation of the ISDA SIMM governance structure – the mechanism for industry feedback and regulatory review has worked as planned.

ISDA’s work will persist as the rules continue to evolve. That includes the monitoring of preparations for the EU FX and phase-three initial margin implementation deadlines, the development of any necessary documentation solutions, and ongoing updates to the ISDA SIMM. ISDA is committed to working with the industry to develop solutions to help firms with their compliance efforts.

The Legal Aspects of Smart Contracts

A lot has been said and written about the potential for smart contracts in the context of derivatives. On our part, we think smart contracts have the potential to unlock value in the derivatives market by offering significant cost and efficiency benefits.

But what exactly do we mean by a smart contract? Is it a fully digital version of the legal agreements we use in the derivatives markets today? Or is it a piece of software that can automate the execution of certain operational actions within those existing paper contracts, but without actually replacing them?

ISDA last week published a paper in conjunction with Linklaters that attempts to answer these questions. The paper delves into the definitions of smart contracts, outlines how they might be used in a derivatives context, and highlights the legal issues they raise.

We have a strong and tested legal framework for derivatives, the ISDA Master Agreement, which has been honed over more than 30 years. But translating that directly into a smart contract context isn’t straightforward. While certain operational clauses – those related to payments or deliveries, for instance – might lend themselves to being automated, others are more subjective or require interpretation or discretion, and will therefore prove more challenging.

ISDA is now taking a critical step in the process by reviewing and updating the ISDA documents and definitions, with the aim of standardizing and formalizing certain clauses to enable them to be more easily represented and executed by smart contract code. This work to future-proof our legal documents will start with the 2006 Definitions for interest rate and currency derivatives.

We’re also looking at how the existing Financial products Markup Language messaging standard could be used in the smart contract space. To lead these developments, a new ISDA legal working group has been set up specifically to focus on smart contracts and distributed ledger. This is in addition to another ISDA initiative to establish the common data and process standards to help drive interoperability of these new technologies.

As in the past, ISDA is working to educate the market, but also to establish industry consensus on the application of operational and non-operational (or discretionary) contract elements. There will be instances where specific elements of the contract can be fully automated, but other elements where natural human language must be applied. Our working groups will unpack these issues, and ISDA is committed to developing industry consensus so there is continuity across platforms.

That would unlock significant efficiencies for derivatives market participants. ISDA’s work to future-proof its documentation is a crucial step to making that happen.

Unlocking Value via Process Standards

At the end of May, I wrote a derivatiViews post laying out ISDA’s ambitious vision for the future of derivatives market infrastructure. The system as it stands is creaky, over-complicated and outdated, increasing cost and compliance burdens for all market participants. New technologies can alleviate many of these problems, but first we need a reform of current standards and practices.

I am happy to report that, in the short time since that blog was published, progress toward this goal has started to pick up speed. ISDA is working with the wider industry to solve one of the major infrastructure problems – the lack of commonality in market processes and events. There is no concrete, shared description of even the most basic market activities that we all take for granted, like posting margin or novating a trade. That means each firm has tended to develop its own policies and procedures for each event, and has represented them differently in internal systems.

When regulators introduce new rules, each institution goes away and implements the text by mapping it to its own internal systems, meaning each firm could view the same requirements through a slightly different lens, creating inconsistencies in how data is represented and what is reported.

ISDA has begun categorizing these core events and actions in the trade lifecycle into a common terminology that can be translated into standardized, machine-readable code. From here, they can be collected into a common domain model (ISDA CDM). This will offer market participants a common representation of fundamental industry processes and concepts – breaking down each event into a ‘before’ and ‘after’ state, and precisely defining the change that occurs between the two. Individual firms won’t need to spend time and effort on developing their own definitions of basic tasks – they can all simply pluck the same definition from the ISDA CDM. That will free up resources for activities that deliver added value to their clients.

It sounds simple, but it’s a huge task. Getting everyone to agree on a set of definitions, and encouraging widespread adoption, will be challenging. That’s why ISDA, with its reach across the market and history of introducing common standards, is the perfect organization to push this work forward.

In September, ISDA should have developed an initial CDM design, and will then decide the format and mechanism for its wider publication. Within the same time frame, we also expect to have expanded the supporting business case for adoption of the ISDA CDM.

The short-term benefits of such a CDM are numerous. When new regulations are introduced, supervisors can communicate their requirements by reference to the CDM and remove much of the current pain around interpretation. If the CDM needs updating, then this could be arranged through discussion with the market to ensure the model remains reflective of industry practice. This would improve consistency of implementation, and transparency.

In the longer term, the establishment of common definitions for key lifecycle events should help facilitate the implementation of shared data storage facilities, distributed ledger technologies and smart contracts. This will enable a single, central, secure representation of each trade, through which trade events can be automated via the standard processes contained in the CDM. This will eliminate the need for constant reconciliation between counterparties, which does so much to gum up current infrastructures.

We will shortly be releasing a whitepaper that will look at the use of distributed ledger and smart contracts from a legal perspective – this will set out the different smart concepts in play, and describe some of the legal and operational challenges involved in bringing them into use.

All of this will be done with a careful eye on compliance, and on optimizing new regulatory obligations. We will also keep the global regulatory community updated on our progress, and we hope to bring in their expertise to help overcome some of the possible hurdles in the road ahead.

As I mentioned in May, this is a bold vision, and will require plenty of tough decisions to be made by the industry. There are a host of operational and legal issues to overcome. But we can’t stay still and accept things the way we are now. We need to push forward and help design a derivatives market that is fit for the demands of the 21st century.

Benchmark Transition Plans will be Critical

Last week saw the US Alternative Reference Rates Committee (ARRC) – a US public-private sector working group led by the Federal Reserve – select its choice for a risk-free rate that could be used as an alternative to US dollar LIBOR for certain derivatives and other contracts in the future. The next step is to think about how to encourage its use and to transition to the new rate – and that’s the really tricky part. Certainty will be critical: market participants will need a clear plan.

The ARRC isn’t the only public-private sector group to be going through this process. Similar initiatives to identify and transition to alternative risk-free rates are progressing in the UK and Japan – part of a broader project to enhance financial benchmarks, which also includes work by benchmark administrators to strengthen the methodology for existing IBOR rates and an initiative led by ISDA to identify robust fallbacks that would apply to IBOR-linked derivatives contracts should an IBOR rate permanently stop being published.

Together, the transition to risk-free rates and the development of IBOR fallbacks will affect trillions of dollars in notional in interest rate derivatives trades. So it’s important that people understand what these developments are and what they mean. It’s also vital that market participants can implement the changes in a way that creates most certainty and least disruption – both now and down the line.

The transition to risk-free rates is particularly challenging, because each case is unique – there’s unlikely to be a one-size-fits-all transition plan that suits all rates and all jurisdictions. Despite this, we think there are some high-level principles that can guide market adoption.

First, it’s critical that the alternative rate is sufficiently liquid to support its role as a key market benchmark. If not, the priority should be to encourage trading in the underlying rate first, before any benchmark transition occurs.

A liquid basis market to enable the hedging of basis risk between the existing interbank rate and the selected rate is also a necessary prerequisite before any transition occurs. As a third principle, formal public-private cooperation should continue (or begin in jurisdictions other than the US, UK and Japan) to ensure the transition is implemented as smoothly as possible. These transitions should allow sufficient time for market participants to make the necessary changes to systems, processes and documents.

It’s also important that authorities and industry participants try to anticipate the future shape of the market. There needs to be a clear understanding of what end users want to achieve and the risks they want to hedge to determine whether there will be a continuing demand for the old benchmark rates. End-user outreach will therefore be vital.

Finally, serious consideration must be given to whether the transitions should apply to legacy trades. Switching the reference rate for existing transactions would likely result in shifts in valuations, which could be disruptive to the market. As a result, we expect the public-private sector transition plans will target new trades only.

Last year, the ARRC proposed a paced transition plan that is largely consistent with these principles. It emphasizes the building of liquidity in the new rate before encouraging market participants to use it for trading. It also highlights the importance of building a market for hedging basis risk between the existing and new rate. Critically, it only refers to transitioning new contracts to the alternative rate, rather than forcing the transition of legacy contracts.

Another question is, what happens to existing and future IBOR contracts should the IBOR rate be permanently discontinued? That’s the focus of a separate ISDA-led working group. Together with the Financial Stability Board, the working group is looking to identify robust fallbacks for key IBORs that can be written into derivatives documents – likely to be the relevant risk-free rates chosen by the respective public-private sector working groups.

Unlike the work to transition to risk-free rates, which will likely focus on new contracts only, we think there’s a logic to identifying a robust fallback for all key IBOR contracts, both new and legacy. That’s because if a tail event occurs and an IBOR rate stops being published, it makes sense for everyone to be using the same, published fallback rate. Certainty regarding which rate to reference would be just as important for legacy contracts.

If that is indeed the case, then ISDA could publish a protocol to help firms alter their legacy contracts to incorporate the fallbacks in an efficient way. This would only work if everyone changes their contracts, though. If only part of the market makes the change to their legacy contracts, firms would face significant basis risk. As all ISDA protocols are voluntary, there would likely need to be regulatory action to ensure everyone makes the change.

This is just part of ISDA’s broader work on benchmarks. Along with being an observer on three public-sector risk-free rate working groups and leading the initiative to develop IBOR fallbacks, we’re also working with the industry to help prepare for compliance with the EU Benchmarks Regulation from the start of next year.

We’ll continue to focus on this area and will inform members and industry about forthcoming changes and implications. As part of that, we’ll shortly be holding a benchmark symposium in New York on July 12. We hope to see you there!

Time Ticking on Next Margin Deadlines

Time has a habit of marching relentlessly on, and revised compliance dates for counterparties to make changes to their collateral documents as part of new variation margin requirements are nearly upon us in some cases. Substantial progress has been made over the past few months because the industry isn’t being complacent – yet there’s still more to do, and little time to do it in.

ISDA has been tracking industry progress on a weekly basis since the beginning of the year. The data shows that more than three quarters of outstanding credit support annex (CSA) agreements have now been amended. That represents a big jump from the 30% just before the original variation margin ‘big bang’ implementation date of March 1 – which, in turn, represents thousands of hours of complex bilateral negotiations with counterparties to agree the changes. We have provided this information to regulators across the globe, and they are keenly interested in the progress that has been made.

But with the variation margin forbearance period set to end on September 1 in some jurisdictions, including the US, there’s little time left to make changes to the remaining 20-25% of CSAs. Along with the end of forbearance, other jurisdictions – Australia, Hong Kong, Switzerland and Singapore – are due to require compliance with their variation margin requirements from September 1.

Given the progress made over the past few months, it might seem like there’s time aplenty to complete the job. But the second phase of the initial margin requirements is also due to take effect on September 1 – which means that phase-one and phase-two banks will be finalizing their initial margin documents, and phase-two firms will be implementing the necessary systems changes. It should also be noted that the ISDA SIMM has been updated to include additional risk factors relating to cross-currency swaps, inflation swaptions and collateralized debt obligation tranches. ISDA SIMM 1.3 was undertaken at the request of the Federal Reserve Bank, and we’re also going through the annual recalibration process and the results will be shared with global regulators. All of this means there will be competing demands for limited resources during the coming summer months.

The scale and complexity of the variation margin repapering exercise has been immense. The March 1 deadline captured banks, asset managers, insurance companies and hedge funds across the US, European Union, Japan and Canada. While the vast majority of those entities already posted variation margin on their non-cleared derivatives, the rules required certain specific changes to be made to collateral documents in order to comply with the rules. ISDA estimates more than 150,000 CSAs needed to be amended – and all changes had to be negotiated and agreed by each pair of counterparties.

ISDA has been focused on helping firms with their compliance efforts, and published a protocol that offers a scalable option for amending multiple CSAs to comply with the variation margin requirements. That protocol remains open, and has been extended to include Australia, in addition to the US, Canada, European Union and Japan. We would urge firms to push ahead with their remaining negotiations, and aim to complete the work as soon as possible.

There is a potentially troubling aspect to this, though. There have been questions over whether regulators might require trades entered into from March 1 to be unwound if they are not subject to regulatory compliant variation margin CSAs by September 1. This action is both counterproductive to good risk management and impracticable, as firms lack a contractual mechanism to force their counterparties to unwind the transactions in those circumstances.

Even if achievable, such a requirement would be unlikely to reduce systemic risk in any meaningful way, given ISDA data that shows approximately 90% of relationships that are in-scope for the repapering exercise are already backed by variation margin, just not with the required changes to the underlying documentation to bring them into full alignment with the regulatory mandated terms. Planning a program to unwind transactions would divert key resources away from the main task of completing the variation margin repapering and implementing the phase-two initial margin changes.

Due to the conditions of the available regulatory forbearance, market participants have been careful to engage in activity that does not present significant credit and market risks. Indeed, some trades entered into from March 1 may offset the risks of transactions entered into prior to that date. Forcing firms to unwind trades would therefore lead to significant market disruption, could result in some entities being left unhedged, and would disadvantage firms in a subset of jurisdictions, which could lead to regulatory arbitrage. That’s surely contrary to the intention of regulators.

ISDA will continue to track the industry progress and keep global regulators informed of the overall number of CSAs that have been renegotiated and updated leading up September 1. We are also helping all phase-two banks prepare for the next round of initial margin exchange utilizing SIMM 1.3.

ISDA’s Vision for a Smart Future

ISDA has a long history of creating solutions for the derivatives industry. The Master Agreement and countless protocols and definitions have contributed to a safer, more efficient market for derivatives users.

Now we face perhaps our biggest challenge to date. Due to tactical regulatory drivers and a lack of historic planning, many basic, vital processes in our market have become unbearably complex and inefficient. This needs to change – and ISDA is focused on working with the industry to produce new standards and ensure the derivatives market is building firm foundations for the future.

In my remarks at ISDA’s recent annual general meeting, I outlined a vision for a derivatives market structure that is more efficient, driven by common data, processes, legal standards and automation. This won’t happen overnight, so the industry needs to start planning for the longer term now. We need a wholesale rethink of the way the market is connected, how trade flows are managed, and how data is created and shared between participants. ISDA is committed to helping in this task, and we will do what we have always done – bring the industry together, find consensus and hammer out solutions.

The root of the problem can be traced back to the succession of requirements introduced as part of the post-crisis reform agenda. The industry has been focused intensely on meeting successive deadlines for clearing, trade execution, reporting, compression and collateral exchange. There has been little time to think about how all of this can best work together. As a result, processes and workflows are over-complex, duplicative and costly to maintain. The absence of a common approach means counterparties need to constantly reconcile details of a trade to reduce the potential for inconsistencies. This is sapping the energy and resources of all concerned.

Technology is the key to greater efficiency and creating value for our members – an issue on which there was broad consensus during our annual general meeting. For the potential of fintech to be fully realized, a strong foundation of common standards and processes must be constructed. Only then can innovators and entrepreneurs take new technologies forward with the confidence they will be interoperable.

In an ISDA white paper published in September, we set out the steps we think are needed to create those strong foundations. A critical aspect is the development and implementation of common data standards to ensure everyone can communicate the economic terms of a trade consistently across the lifecycle. ISDA has published principles governing product standards, and we have begun work to define appropriate product taxonomies. We’ve also been working with regulators to develop a suitable trade identifier framework, and will continue to feed into this process.

In addition, we need standards for processes – an agreed set of definitions for specific lifecycle events or actions, which could be encoded as common domain models that are available to everyone. This would not only aid interoperability; it would also provide a transparent and consistent view of how each step in the process works. This would help oversight and rule-making and simplify regulatory implementation, as specific changes to an affected common domain model could be recommended in order to comply.

Once that’s complete, we can develop smart contracts that provide an automated legal framework for derivatives, based on the standardized data and processing hierarchy. Here, the existing Financial products Markup Language framework could be leveraged and extended to support self-executing transactions – in fact, we’ve already rolled out a proof of concept of this.

Finally, we can’t ignore all the good work that ISDA and its members have contributed on the legal front. ISDA will work to future-proof our legal documentation by developing solutions to update and automate our product definitions, as well as exploring various smart contract applications.

These aren’t just ideas. We’re working with the industry – sell side, buy side, technology firms and lawyers – to put them into practice today. There are a lot of opinions out there, but achieving consensus on new standards is something ISDA has plenty of experience in, dating back to the development of the ISDA Master Agreement 30 years ago.

The goal we have set is a fundamental overhaul of the derivatives markets. This will bring increased automation, make it more cost efficient, and enable opportunities for innovation. This goal is ambitious, but ISDA and its members have the desire to bring about the necessary change to ensure the vitality of these markets in the future.

Certainty is Good for the Economy

It is often forgotten – or ignored – that derivatives serve a real economic purpose. They help companies manage risk, which creates certainty and stability. That stability gives those companies the confidence to invest, borrow, grow and hire. That contributes to economic growth.

ISDA recently put together a short video, along with a fact sheet, to highlight a few examples of how derivatives help companies run their businesses better.

Examples include companies using derivatives to lock in the cost of issuing debt to finance new investments. Exporters using derivatives to create certainty in the exchange rate at which they can convert future overseas revenues. Pension funds using derivatives to protect the value of pensions for future retirees. Food producers using derivatives to hedge crop and livestock prices. And banks and mortgage providers using derivatives to manage the risk from their loan books, enabling them to keep on lending.

In each case, these entities are using derivatives to create certainty. No one can predict how markets will move in future, but being able to lock in a foreign exchange or interest rate that a firm is comfortable with enables that company to better plan for the future. That’s incredibly valuable.

Now, let’s be clear: we think derivatives markets need to be safe and efficient, and the trading of these products needs to be accompanied by sound risk management. That’s why we have supported regulatory efforts since the crisis to improve transparency and mitigate counterparty credit risk. As a result of those measures, the financial system is more resilient than ever before.

But the bottom line is that derivatives continue to be used by a whole range of companies because they’re useful – because they help them manage risk. If they didn’t find them beneficial, they wouldn’t use them.

But don’t just take our word for it. Here are a couple of public statements from regulators in the US and Europe charged with reforming how derivatives are traded.

“[L]et us again be reminded of the essential role of global derivatives markets: to help moderate price, supply and other commercial risks – shifting risk to those who can best bear it from those who cannot. Thus, well-functioning global derivatives markets free up capital for business lending and investment necessary for economic growth – economic growth that still remains far too meager on both sides of the Atlantic.”

Acting CFTC chairman J. Christopher Giancarlo, ISDA Annual General Meeting, May 10, 2017

“Most Americans do not participate directly in the derivatives markets. Yet these markets profoundly affect the prices we all pay for food, energy, and most other goods and services. They enable farmers to lock in a price for their crops, utility companies and airlines to hedge the costs of fuel, exporters to manage fluctuations in foreign currencies, and businesses of all types to lock-in their borrowing costs. In the simplest terms, derivatives help businesses throughout the US economy manage risk.”

Former CFTC chairman Timothy Massad, Economic Club of New York, December 6, 2016

“Derivatives are a key part of our financial markets and account for hundreds of trillions of euros in volume. Under the right conditions, they contribute to financial stability, by allowing market participants to redistribute risk among each other. For example, they allow exporters to fix their prices despite fluctuating exchange rates, and banks to offer fixed-rate mortgages even as interest rates move.”

Valdis Dombrovskis, vice-president, European Commission, May 4, 2017

And here’s just one public statement from an association representing derivatives end users. There are plenty more out there in the public domain.

 “The use of derivatives to hedge commercial risk has key economic benefits. It allows businesses – from manufacturing to healthcare to agriculture to energy to technology – to improve their planning and forecasting, manage unforeseen and uncontrollable events, offer more stable prices to consumers and contribute to economic growth.”

Letter from Coalition for Derivatives End-Users, January 26, 2016

Safe AND Efficient Markets

Those of you who made the trip to Lisbon last week for our 32nd annual general meeting – or followed our updates and live streaming on Twitter – will know that several key themes dominated the event. But most can be grouped under a single word: efficiency.

This plays directly to ISDA’s mission statement to promote safe and efficient markets – a mission that is driving our focus on the future and our commitment to develop innovative new solutions. Attention from regulators and the industry in recent years has understandably been on the first of those – safety – but efficiency is just as important. Without it, costs rise and access to risk management tools diminishes.

There’s no doubt the financial system is now safer, more transparent and more resilient as a result of the post-crisis Group of 20 reforms. We think that progress is important and must be maintained. But we also think the regulatory framework can be made to work better by cutting complexity, eliminating duplication and removing unnecessary compliance burdens. As I pointed out in my AGM opening remarks, and as discussed in our panel discussion on public policy, there are many examples of complexity in the rules that result in higher costs for derivatives users and ultimately discourage trading, investment and hedging.

The reporting rules are a case in point. Most jurisdictions now have reporting rules in place, but the data that’s required to be reported and the form it has to be sent can differ significantly. In the US, for instance, Commodity Futures Trading Commission and Securities and Exchange Commission rules diverge on required data fields and the format of submission. This creates unnecessary duplication and inconsistency, without having any obvious benefit from a systemic risk-reduction perspective.

Fortunately, both European and US regulators are now reviewing their rules with an eye to making refinements where necessary. We welcome these initiatives, and believe eliminating pointless complexity and duplication is an important requisite for efficiency. Achieving greater cross-border harmonization and conducting thorough impact studies before all the rules come into force to understand their effect on the entire derivatives ecosystem are also important.

Looking at the regulatory framework is just one element of the drive for efficiency, though. We also need to remould the derivatives data and processing infrastructure to ensure it is fit for the future. The regulatory reform of derivatives markets has resulted in an array of new requirements and infrastructures – clearing houses, trading platforms and trade repositories – but the succession of deadlines has caused firms to take a tactical approach to compliance. The tight time frames haven’t given participants much time to think about the bigger picture.

The result is a lack of common standards and processes, and the need for constant reconciliation between counterparties. This inefficiency increases the cost and complexity of running a derivatives business.

A vital part of the answer is to develop a consistent data and process hierarchy. By using common data standards for products and trades, and agreeing standard processes that are encoded as common domain models, the industry can ensure the foundations for future growth are on a firm footing – as well as pave the way for the use of innovative new technologies like smart contacts.

ISDA published a white paper last September that set out the improvements in data and processes that are needed, and we’re committed to leading that effort. We’re keen to work with all participants – traders, technology firms and lawyers – to make this a reality, in the same way ISDA worked with the industry 30 years ago to achieve consensus on the ISDA Master Agreement.

As discussed on our technology panel at the AGM, the challenges are significant. But we need to be bold in developing a re-ordered, more efficient workflow. The continued efficiency of the derivatives market depends on it.

At ISDA, we have our eyes firmly fixed on the future, and we’ll look to bring the industry together to forge a consensus on the path forward. By drawing on our legal, data and technology expertise, the aim is to create the standards and processes needed for the market to function efficiently for the next 30 years.

Thanks to the 750 or so members who joined us in Lisbon and helped make the event a great success. Thanks also to the financial media who attended. We especially appreciate the global policy-makers – Svein Andresen (Financial Stability Board), J. Christopher Giancarlo (Commodity Futures Trading Commission), Steven Maijoor (European Securities and Markets Authority) and Kay Swinburne (European Parliament), among others – who provided their perspectives on key regulatory issues in the global derivatives markets.

Expanding ISDA SIMM Coverage

Developing the ISDA SIMM was never going to be a one-time deal – for ISDA to roll it out for the September 2016 implementation, and then walk away. It was always recognized that regular updates and recalibrations would be necessary, in line with regulatory requirements. And an important set of updates was introduced this month.

The ISDA SIMM now includes additional risk factors relating to cross-currency swaps, inflation swaps and collateralized debt obligation tranches, meeting a deadline set by US regulators last year for the model to incorporate those risk factors.

This is an important development for the industry. Cross-currency swaps, in particular, comprise a large portion of the non-cleared derivatives market – roughly $15 trillion in notional, according to data reported to US swap data repositories and compiled by ISDA SwapsInfo.org – and are widely used by end users to hedge their foreign currency exposures.

Failure to make the required updates would have meant having to calculate initial margin on new cross-currency swap transactions using the much more conservative standard table set by regulators, resulting in punitive margin requirements. This could have made this important hedging instrument uneconomic for some end users.

Support for these additional risk factors – rolled out on April 1 – is part of a series of phased updates requested by US regulators at the time they approved use of the ISDA SIMM by phase-one firms last August. Given the need to also run a parallel annual recalibration and methodology review, the ISDA SIMM Governance Executive Committee opted to focus on those products and risk factors that ISDA members had highlighted as priorities and where the necessary data history existed – with cross-currency swaps top of that list.

With that achieved on schedule, attention will focus on the next set of deadlines and priorities, as well as meeting the September 2017 implementation date for the second wave of firms subject to initial margin requirements. The ISDA SIMM Governance Forum is working to identify those institutions affected, and to share knowledge and experience from the September 2016 implementation.

Seven months on from the first implementation date, the ISDA SIMM is being widely used by phase-one firms, and is expected to be just as broadly adopted by the second wave. That was the point of the ISDA SIMM: to develop a simple methodology that could be used by everyone. A simple, industry wide model will never be as sophisticated as a bells-and-whistles bank internal model, but it will cut down on the problems that could have occurred had everyone developed their own, disparate methodologies. It won’t eliminate disputes but it should limit them, and the fact that everyone is using the same simple, transparent model will make it easier to trace the causes of any differences.

The ISDA SIMM will continue to be a major priority for ISDA, and the ISDA SIMM governance framework will ensure the model continues to meet regulatory requests, responds to member feedback, and reflects changing market conditions in a transparent, inclusive way.