Isda to Release Definitions on Web-Based Platform

The International Swaps and Derivatives Association (Isda) is planning a web-based versioning platform for the upcoming release of its 2020 Isda Interest Rate Derivatives Definitions. The trade organization plans to launch the platform by the end of this year.

The platform will provide the current version of a definition at the time of a trade execution. It will also have features like allowing users to look at contractual terms and hyperlinked definitions. Isda plans to offer code for some definitions using functionality available in its Common Domain Model (CDM), allowing computers to interact with the mechanical parts of the definitions.

The definitions have traditionally been manually published. The 2006 Isda Definitions were available as a bound booklet or an e-book, written to provide a basic framework for the documentation of privately negotiated interest rate and currency derivative transactions. Prior definitions were published in 2000 and 1991.

“We conduct this kind of root-and-branch review of definitional booklets periodically to see whether they have kept pace with the way the market has changed,” says Rick Sandilands, senior counsel for Europe at Isda.

Since the definitions came out in 2006, Isda has made amendments to it using a supplement process, with just under 70 supplements available today. For people to understand legal terms, they need to read not only the booklet, but also the supplements.

“The definitions are currently all paper-based and in need of modernization,” Sandilands says. “An important part of that is making them consumable in a much more user-friendly way, both for humans and computers.”

The platform will allow users to do more than just access definitions. Isda’s definitions constitute the legal contractual terms of transactions its users engage in, and are used in an estimated $450 trillion worth of contracts, based on figures from the Bank of International Settlements.

“When users enter into contracts, they will be able to go to the user interface and see the contractual terms they are incorporating into their contracts,” Sandilands says. “This platform provides us not only with the ability to give people this authoritative, definitive version of the definitions, but also to overlay the tools they can use in order to help them work their way through the consequences for their contracts following a particular event.”  

As an example of how the platform could make the process simpler: An option has a certain expiry date, and it might happen that the markets have to close on that day. The user will be able to look up the expiry date on the platform, find that it refers to another defined term, and click through to that other defined term.

Market closure in China due to Covid-19 was a scenario that Isda had not anticipated when formulating its 2006 definitions. Traders who had options that expired when the markets closed did not know whether they had any rights, or whether those dates would move backward or forward. Isda is expected to address this issue in the upcoming definitions.

“We are still developing our ideas behind this platform, but we could potentially add other materials. For example, you could have a video explaining how one set of provisions interacts with another set of provisions, providing a multimedia experience,” Sandilands says.  

Similar to previous releases, Isda will need to amend these new definitions because of developments in the market that will require updates. “You will be able to view different versions of the definitions, allowing users to compare and contrast them in a much more user-friendly manner—for example, by producing blacklines to show how they changed over time. That could be very useful for lawyers and operations staff at market participants,” Sandilands says. 

Blackline refers to the option available in software such as Microsoft Word to compare two different versions of a document, helping to identify changes such as text that has been added or deleted. 

A supplementary offering with the new definitions will have Isda providing the code for some of the definitions. Because of its experience with CDM, which looks at producing a model as code for how certain processes and tasks are commonly performed in the derivatives markets, Isda already has a lot of the functionality and would only need to repurpose it for the new definitions.

“We will not code everything because some parts of the definitions are not mechanical in nature,” says Ian Sloyan, director for market infrastructure and technology at Isda. “For example, the requirement to act in good faith and in a commercially reasonable manner does not lend itself to being coded. Instead, our focus will be on coding the mechanical elements of the definitions, such as how certain payment amounts are calculated.”

Instead of working through paper documents, a code will explain what to do if a certain event takes place, for example. An example of the type of term that can be codified is day count fraction. This refers to the number of days in the month divided by the number of days in the year.

“We can describe certain elements using a formula that makes them much more standardized and less susceptible to people taking a different interpretation of what the words mean,” Sandilands says. “This means we will be able to code the mechanical elements of the definitional booklet and make them available through the CDM.” 

The calculation will need to be consistent because, for example, another developer on the other side of the world, building a system in Java, would need to implement the same day count fractions. Using the same code, they should be able to implement and calculate the same number when given the same parameters.

“We have many examples where, because of the narrative way previous sets of definitions have been drafted, people have had to interpret the legal text and then try and code that equation,” Sloyan says. “That has sometimes led to breaks in the way counterparties to a contract have processed their payment and receipt obligations in the past. The 2020 Definitions will express those concepts formulaically, allowing us to provide market participants with coding that should significantly reduce such breaks.”

Definitions that could be coded are ones that define how to do a task or a calculation, versus just explaining what a certain type of data means. The latter may not be useful to codify.

“It’s important to note that this process is not a one-way street,” Sandilands says. “It’s not just a question of coding what is in the definitions, but also understanding how market participants use the definitions within their systems. Where appropriate, we are updating the definitions to facilitate these practices, rather than trying to make market participants change their behavior to match the definitions.”

Isda still needs to select a vendor to build the platform. 

With Covid-19 and other financial pressures, many banks and institutions might be reluctant to invest resources in adopting a new platform. Adoption of previous definitions took a long time. 

“We know from experience that adoption of new versions of our definitions can take time,” Sandilands says. “For example, some trades are still documented using the 2000 definitions. However, since we published the 2006 Isda Definitions, a lot more derivatives are traded via central counterparty (CCP) platforms. Once CCPs switch to the 2020 Definitions, other market participants may be incentivized to switch to them, too, in order to maintain alignment between their cleared derivatives and non-cleared derivatives portfolios.”