ISDA to Bring Cryptoassets in Master Agreements
Posted by Colin Lambert. Last updated: December 15, 2021
In what is perhaps another sign that the mainstream financial industry is likely to embrace digital assets, the International Swaps and Derivatives Association (ISDA), says it is seeking to develop common legal standards and definitions for digital asset derivatives, “recognising that crypto assets are a unique product class”.
In a white paper, ISDA observes that digital assets have the potential to transform the way in which financial markets operate and how investors interact with the financial system. From a market value of effectively zero a decade ago, the total value of all digital assets is today estimated to be approximately $3 trillion. ISDA says this growth has been accompanied by a corresponding increase in the number and diversity of market participants.
The growth of derivatives is a “significant step” in the continued development of the cryptoasset space, and ISDA says that these products increase transparency and liquidity in the digital assets market by facilitating price discovery and allowing market participants to hedge risk. It adds, however, “It is vital the growth of this market is based on firm foundations. The creation of contractual standards will therefore be central to the development of a safe, efficient digital asset derivatives market.”
The paper identifies technology and events that could disrupt the digital assets derivatives market and offers a framework for dealing with them. It also explores the valuation of such assets and how they might interact with the existing ISDA documentation framework. It also explains how ISDA will develop digital product templates and definitions and how they can be integrated within the operational and technological infrastructure that is being designed and implemented across the digital asset ecosystem.
“Contractual standards have been a cornerstone in the growth of safe, efficient and liquid global derivatives markets,” ISDA states. “They allow market participants to transact in confidence using clearly defined provisions for business-as-usual execution and settlement, while also setting out a clear path for the resolution of many different asset- and market-related risk scenarios.
Contractual standards also help to minimise unintended basis risk in otherwise similar products and reduce counterparty credit risk (with corresponding reductions in regulatory capital) by providing the contractual ability to net transaction exposures,” it adds. “In this way, contractual standards promote greater liquidity, more efficiency and reduced market and credit risk.”
In terms of disruption events, ISDA highlights forks, airdrops (the issuance of a new digital asset to the holders of an associated digital asset), cyberattacks and other disruptions to the underlying technology, the untethering of a digital asset from the underlying asset against which it is stabilised, and a change in law or regulation – especially significant given the lack of clarity over the regulatory framework in the US.
In developing what ISDA stresses is the “first step in the journey”, it says it has drawn on the expertise of members of the ISDA Digital Assets Legal Group and, more broadly, the insights of various firms operating in the digital asset market.
“As this work progresses, ISDA will deepen its relationships with these firms and facilitate greater collaboration among traditional market participants, the crypto community and other relevant stakeholders to produce mutualised solutions that serve all participants and contribute to the development of a safe and efficient digital asset derivatives market,” it says. “As the broader financial industry seeks to take advantage of these opportunities, the development of a robust and liquid derivatives market will be crucial, as will the emergence of the contractual standards underpinning those transactions.”