Most people working in derivatives would probably agree that if the market was built from scratch today, the likelihood is it would look very, very different.
Rather than a patchwork of disjointed, manually intensive processes, there would be greater coherence and automation. Rather than each firm having to develop and maintain its own unique catalogue of data and definitions, there’d be a standard representation of trade events and actions that everyone used. And rather than having to reconcile trades after each step in the lifecycle to eliminate inconsistencies, actions and events could be applied to a single, central record that each counterparty would have access to.
ISDA has now taken the first step to making this a reality with the rollout of a conceptual version of the ISDA common domain model (CDM). CDM version 1.0, published today, introduces the concepts to create a standard blueprint for events and actions that occur throughout the lifecycle of a trade. This is intended to be more than a data or product standard that focuses on one specific area or function: it gets to the very fabric of how derivatives are traded and managed across the lifecycle, and how each step in the process is represented.
This type of common representation is crucial if the industry is ever going to unlock the value presented by new technologies, such as distributed ledger and smart contracts. The current situation is simply unsustainable. Legacy infrastructures are old, complex and duplicative, and have been layered with additional processes – clearing, reporting, margining – in response to regulatory requirements. These infrastructures are reliant on manual intervention, and constant reconciliation is required to fix the mismatches caused by variations in how each firm records trade lifecycle events. It’s just not scalable, and it’s not fit for the 21st century.
At the same time, banks are facing increased capital requirements, high costs and pressure on profitability. New technologies offer the potential to fundamentally reshape this infrastructure by reducing operational risk, streamlining increasingly cumbersome and time-consuming processes and cutting costs. That’s why many banks have already invested in technology initiatives, and why a number of smart contract and distributed ledger proof-of-concepts have sprung up.
But automating a single business or function isn’t enough. Similarly, unilateral development of bespoke technologies will inevitably lead to the same disjointed and fragmented market infrastructure that we see today. In order to realize the full potential of these technologies, and to ensure they can work seamlessly across firms and platforms, we need to develop a common set of data and processing standards that everyone can access and deploy. Which is why our members – the very members who have invested in these technology initiatives, as well as the platforms that have launched them – are working with us on the ISDA CDM.
There are other advantages to the CDM, even without smart contracts and distributed ledger. Having a consistent representation of trade events and processes ensures firms do the same thing, in the same way, at the same time, which cuts down on the need for reconciliations. It also means regulatory updates could be made with reference to the standard blueprint, reducing time and effort to interpret and meet regulatory requirements, and ensuring accuracy and consistency in regulatory reporting.
In putting together the conceptual model for the ISDA CDM, we have leveraged our track record and expertise in developing standard legal documentation and product definitions, with the aim of creating firm foundations for industry transformation. We’ll now gather feedback from the industry – technology firms, infrastructure providers, end users and traders – and then develop a digital version of the ISDA CDM. We’ll also look to extend the model to other products and functional activities.
But this work cannot be done in isolation. In parallel, we’re working to consider the legal and governance issues relating to smart contracts, and are looking to update and future-proof our definitions to enable automation.
This is a first step in what will be a long journey, but we think it’s a journey that has to be taken. We need to ensure the derivatives market is fit for purpose for the 21st century.