The derivatives industry continues to push for the digitalisation of documentation management. Bob Currie explores the digital solutions available today, how they are evolving and what firms can do now to avoid common mistakes as they move to digitalisation.
Industry initiatives to digitise contract negotiation and document generation have played an important part in removing manual error and in reducing aggregate trading costs for users of derivatives. These steps to improve accuracy in pre-trade functions have also been fundamental to measures to promote end-to-end automation across the trade lifecycle for derivatives and other transaction types.
Inefficiencies may lead to suboptimal performance
Rapid growth in the volume of legal documentation linked to derivatives trades has made it unrealistic to rely on traditional contract negotiation procedures which are commonly time intensive, involve heavy repair and reconciliation costs and which typically require data to be entered manually into a firm’s document repositories and its collateral, risk and operations systems.
This inefficiency may also lead to suboptimal performance from a business perspective. Firms may miss out on business opportunities when they do not have a clear understanding of the data contained within their contract portfolios and the tools to extract this data efficiently.
For Akber Datoo, CEO at D2 Legal Technology, the need for banks to have efficient mechanisms for tracking key trading agreement terms has been illustrated by a range of market events and regulatory obligations. One example is FINRA’s Rule 4210 margin obligations, which requires broker dealers, when engaging in certain transactions, to keep a minimum amount of margin within customer accounts. Another is the requirement that systemically important financial institutions should maintain an effective recovery and resolution plan, or ‘living will’.
Among other expectations, this demands that a bank can provide key information to supervisory authorities to ensure that, in case of distress, bank resolution can be delivered safely and quickly, without destabilising the financial system or exposing taxpayers to the risk of loss.
Digital solutions
Based on a long career working in derivatives, International Swaps and Derivatives Association (ISDA) senior counsel, Commercial Product Development, Heather Smith is well positioned to reflect on the challenges presented by these inefficiencies in client onboarding and pre-trade functions. She notes that contract negotiation and client onboarding is typically a heavily manual and labour-intensive process, requiring significant back and forth within the firm and between counterparties, numerous manual revisions, comments and approvals, and multiple rounds of version reconciliation to ensure team members are working from the most recent draft. These challenges are detailed more fully in a series of informative case studies in the ISDA report, Unlocking Efficiencies and Savings: Digitized Legal Document Negotiation (ISDA: 2022).
However, the advent of an online digitised solution, ISDA Create, enables firms to extract key structured legal and commercial data while automating the creation, negotiation and execution of key derivatives documentation. This solution, developed as a partnership between ISDA and Linklaters, was initially launched in January 2019 to help firms to negotiate documentation to comply with regulatory Initial Margin (IM) requirements. The platform has subsequently been extended to cover an extensive library of ISDA documentation, including ISDA Master Agreements, Variation Margin (VM) credit support annexes, amendments to legacy contracts and account control agreements for certain custodians.
For Deepak Sitlani, Capital Markets Partner at Linklaters, the integration of ISDA Create and CreateiQ [the contract lifecycle management platform, developed and operated by Linklaters, which supports ISDA Create] into wider ecosystem technology platforms such as S&P’s Counterparty Manager, is improving the efficiency of the contracting process and delivering downstream data benefits for industry participants.
He notes that more than 450 organisations are now registered on the CreateiQ platform, representing growth of almost 50 per cent since 2022.
The CreateiQ platform can be used to digitise any document type, explains Linklaters Capital Markets senior associate Hannah Patterson Smith, although it is best known for its expertise in digitising complex capital markets documents such as those derivatives, repo and securities lending agreements published by their respective trade associations.
In preparation for the U.S. Securities Exchange Commission (SEC) requirement that cash market and repo transactions in US treasury securities should be centrally cleared, Patterson Smith indicates that Linklaters has already digitised the first SIFMA Master Treasury Clearing Agreement (‘done-with’ schedule) and circulated this for client review – and it expects to digitise the further agreements as soon as they are finalised by the industry. “This will support the industry with the option to use technology to meet a tight regulatory deadline for a large documentation exercise,” says Patterson Smith.
This central clearing obligation for in-scope UST trades is mandated for cash sales and purchases in the secondary market by the end of 2025 and for repo transactions by 30 June 2026.
The new SIFMA Treasury Clearing documents have been drafted by the Securities Industry Financial Markets Association (SIFMA) and its counsel in a way that is designed to lend itself to digital contracting, add Sitlani. “This shows that process improvements and design thinking are now being considered at the inception of new industry agreements to support the industry in the move towards digital contracting.”
Advances and mis-steps
Allocating budget to a legal tech upgrade may help firms to move beyond their paper-based document negotiation processes, but it will not provide an optimal and sustainable solution without a thorough review of their documentation structures and data governance.
D2LT’s Datoo observes that some banking institutions have spent heavily on their organisational design, processes and systems to support their trading agreement data management requirements, but with mixed results across the industry.
Success in this area is heavily dependent on data quality and governance, he notes – on having a clear understanding of data requirements to support business optimisation, regulatory reporting and operations. These data governance and data quality challenges cannot be resolved simply by spending on a technology solution alone. Firms that have succeeded in this area have started with their legal data strategy and roadmap.
To address these data governance priorities, and to lay the foundations for improved straight-through processing (STP) rates across the trade lifecycle, Linklaters’ Patterson Smith indicates that CreateiQ has been developed using a ‘data-first’ approach. Contract templates are digitised to maximise downstream data benefits and data can be extracted through Excel reports and as JSON data via application programming interfaces (APIs) for clients to use in any systems and processes that they wish.
“This data-led approach provides maximum flexibility for clients to decide what contract data they want to utilise and where,” – Hannah Patterson Smith, Linklaters
“This data-led approach provides maximum flexibility for clients to decide what contract data they want to utilise and where,” says Patterson Smith. The integration with S&P’s Counterparty Manager also provides integrated data benefits across the counterparty ecosystem for users, maximising efficiency and reducing operational risks.
Counterparty Manager makes counterparty credit information available to bank credit teams, notes ISDA’s Smith, enabling due diligence on the counterparty prior to approving the trading agreement. ISDA Create then becomes part of the client onboarding lifecycle by providing users with a record of the negotiation process, generating contract agreements as structured data and enabling revisions to be made to contracts that are already in place.
Looking to 2025, ISDA and S&P Global plan to bring the ISDA Notices Hub into this ecosystem. This will enable instantaneous delivery and receipt of critical termination-related notices under ISDA and other master agreements and will help to ensure that address details for physical delivery of these notices are up to date.
Building blocks for digitisation
To digitise contract agreements and to communicate this information digitally, it is necessary to have a structured medium of communication in place with digitally represented words and phrases linked to specified business outcomes.
By this fact, the development of clause taxonomies and libraries for the key master trading agreement types has been important in establishing standards to support process optimisation and effective tooling, such as automation of document generation and approval processes. A clause taxonomy and library offers a collection of common clause variants and model wording, linked to specified business objectives, that can be used to create standardised documents.
Also, steps to promote utilisation of the common domain model (CDM) for representing legal agreements have been critical to allowing more efficient and successful data extraction from legacy contracts – as well as the use of artificial intelligence (AI).
In driving for end-to-end automation, D2LT’s Datoo suggests that consideration needs to be given to the legal agreement data model used for the negotiation of agreements, set alongside that needed to support downstream legal agreement data requirements.
“To ensure success, and to avoid overburdening processes, the data model required to support document negotiation is likely to be a subset of the data model that a firm needs to have in place for business optimisation, regulatory reporting and operational management.” – Akber Datoo, D2 Legal Technology
“To ensure success, and to avoid overburdening processes, the data model required to support document negotiation is likely to be a subset of the data model that a firm needs to have in place for business optimisation, regulatory reporting and operational management,” explains Datoo. “The relationship between the two needs to be well understood – and use of industry clause taxonomies and libraries, together with the CDM, supports that.”
Significantly, the use cases for CDM and the clause taxonomy and library extend well beyond the financial services industry, providing a foundation for digitisation of legal contracts across global business more broadly. For example, D2LT indicates that it is currently guiding an insurance association and a commodities association through digitalisation, using clause taxonomies and libraries as its methodology.
Reflecting on the obstacles to progress, Datoo notes that some firms have simply purchased a tool as a magic bullet to improve client experience and efficiency in creating trading documentation and in managing data in executed agreements. There have been plenty of poor choices deriving from selecting a tool without considering the business architecture first – decisions resulting not only in wasted spend, but sometimes also in business losses and regulatory fines.
“The biggest issues have arisen when attempting to run before one can steadily walk on firm data foundations,” he concludes. “It is incredibly difficult to embrace end-to-end STP flows when the data this is built on is ill-defined or it lacks appropriate lineage.” Moreover, forward-looking applications relating to use of smart contracts and AI will be unworkable, and will fail to deliver promised return on investment, without addressing these data preconditions.
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