ISDA CEO Scott O’Malia emphasized the need to develop uniform legal standards for crypto derivatives contracts. In an ISDA blog, “derivatiViews,” Mr. O’Malia said that ISDA formed a digital asset documentation working group to explore the subject.
Mr. O’Malia stated that financial institutions’ current reliance on either amended versions of ISDA documentation or bespoke agreements in order to trade digital asset derivatives is problematic because it causes a lack of standardization that results in (i) greater risk and (ii) reduced transparency and liquidity. As with interest rate, foreign exchange and equity derivatives, Mr. O’Malia said that different legal standards should be developed for different crypto products. He emphasized that such standards can take into account, among other things, (i) the scope of the products being traded, (ii) the timing of valuation (considering that digital assets trade around the clock), (iii) the effect of transaction fees, and (iv) the form of settlement (i.e., cash settlement or physical settlement).
Mr. O’Malia reported that ISDA’s new digital asset legal and documentation working group has begun studying these issues. Further, Mr. O’Malia stated that the working group intends to publish a paper by the end of 2021 that outlines a path toward developing standards for, and improving the efficiency of, the digital asset derivatives market in a way that conforms to current digital platform development.
Commentary
Considering how swiftly digital asset markets are developing, particularly with respect to derivatives, the advent of an industry working group for the standardization of digital asset derivatives documentation is timely. Moreover, it is strong evidence that digital asset markets are becoming more mainstream and institutionalized.
Mr. O’Malia identified a number of important issues that will be considered by the working group in its efforts to develop standardized documentation for digital asset derivatives, including considerations specific to the use of blockchain technology (e.g., the occurrence of a hard or soft fork). In addition to the considerations outlined by Mr. O’Malia, a few other factors that it might be prudent to consider include: (i) whether differences in reference assets’ risk and liquidity profiles warrant distinct documentation based on reference asset type; (ii) the uncertainty surrounding the regulatory status of digital assets generally, including jurisdictional differences in regulation; (iii) how to determine acceptable forms of digital asset collateral, particularly in the event of an airdrop, fork or other technological issue; and (iv) mechanisms for pricing and valuation disputes, especially when dealing with nascent markets or thinly traded products.
Ultimately, interested parties should pay close attention to developments coming out of the new working group, as the group’s efforts will very likely be useful for building further understanding of the issues pertinent to digital asset derivatives markets generally.
Cadwalader’s Steven Lofchie contributed to this comment.
