Since the launch of ISDA (the International Swaps and Derivatives Association) in 1985, there has been a push by both regulators and industry participants to standardise the documentation used within the OTC derivatives market. That said, 20 years on, questions about standardisation are still being asked.
Regulations such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), and the European Markets Infrastructure Regulation (EMIR) have had an impact on where and when OTC derivatives can be, for example, traded, cleared, and /or margined but has had minimal impact on how these derivatives contracts are negotiated and the terms included in the contracts themselves.
So how far has standardisation come?
Well, given the increasing regulatory scrutiny on the OTC derivatives market, there is a need – now more than ever, to ensure that OTC derivatives contracts are well documented and carefully negotiated.
Banks (sell side), and hedge funds (buy side), (broadly speaking) want to protect their interests and their bottom line, so that in the event that something goes wrong they can exit their trading relationship as timely and cost-effectively as possible.
ISDA and the industry have made tremendous progress identifying commonly traded terms and lifting these into industry standard agreements. However, negotiators and those executing the contracts need to understand each and every clause within these “industry standard” agreements, because one dealers “standard” is different to another’s. A standard contract, a standard long form confirmation, or standard ISDA Master Agreement, often gets “tweaked” by a legal department and takes on a different connotation to its original starting point during the negotiation process.
So will standardisation happen?
There is an increasing pressure from the regulators, and regulations such as Dodd Frank, to improve the efficiency and transparency of the OTC derivatives market. This pushes the argument for standardisation across contracts and agreements.
ISDA remains the benchmark and the bedrock for a large part of the OTC derivatives market. So everyone using the same set of definitions and user guides makes sense, but legal departments, credit departments, trading desks and ultimately negotiators must ensure that the financial institutions they represent are adequately protected.
That said negotiation does not have to be lengthy nor inefficient. With the development of automated document generation tools, document digitisation tools, coupled with collaboration technology in a digital environment, speed, efficiency and control can be tremendously improved.
The bottom line is, every financial institution has a bottom line that needs protecting. The “industry standard” OTC derivative contracts will continue to become standard as more commonly used terms are imbedded within them or referenced in standard supplements (“contract simplification”). Inevitably there will always be negotiation as financial institutions protect themselves and their own interests in a worst case scenario, but standardly using the standards, whilst embracing the new technology will ensure the negotiation process is much faster, more efficient and more controlled.