A protocol is, at its essence, a contractual amendment mechanism that automatically incorporates specific legal language and terms into existing signed relationship documents.
Nice legalese, but what does this actually mean?
It means, in short, that it prevents financial institutions – both buy-side and sell-side – from having to re-negotiate all of their existing agreements and contracts. This is a huge cost saving, both in terms of pure monetary value and people time. It also streamlines the market, and ensures that the buy-side and the sell-side are agreeing to the same principles and terms in advance of the protocol being implemented.
So what’s new with protocols?
The latest ISDA Protocol; the ISDA Resolution Stay Protocol, already has the support of 18 of the major banks. The protocol temporarily prohibits counterparties from terminating their trades in the instance where it looks like a counterparty will default on its obligations.
The protocol creates a 48 hour stay; a short term postponement that prevents banks from acting recklessly (i.e. terminating trades and turning the market against an ailing financial institution). This should allow the Fed (or other regulatory bodies) to better manage a crisis and prevent a re-occurrence of 2008, where there was a global economic meltdown following the collapse of Lehman Brothers (in similar circumstances).
The terms of the new protocol have been agreed in principle, and the protocol will take effect from January 1, 2015. It will govern both new and existing trades between adhering parties, and it’s thought that from the implementation period, in November 2014, many more financial institutions will want to adhere to the resolution.
So why adhere to the protocol and what does adhering involve?
Adhering is entirely optional, but there are three key reasons as to why parties adhere to protocols:
- Money. Adhering to a protocol is cost effective. It avoids costly re-negotiations and repapering efforts that would otherwise be necessary.
- Time. Adhering to a protocol is time effective. It saves a number of areas of financial institutions, not least the legal, negotiations, and operations departments, time and resources.
- Standardisation and Consistency. Protocols are agreed before being implemented. This enables a consistent approach for market participants, which helps to standardise the market as a whole.
- The traditional adherence process for ISDA Protocols requires the submission, by email, of an adherence letter signed by an authorised signatory. In 2012 though, ISDA automated its adherence system to streamline the process to make it more efficient.
As with most automated systems, ISDA now allows any parties wishing to adhere, to generate and submit their adherence letters direct to the ISDA website. Parties are then required to complete a questionnaire.
Protocols rarely make the headlines, which is perhaps a testament to their success. Their introduction in the late nineties has relieved administrative burdens, saved financial institutions untold time and money, and made immeasurable differences to the OTC derivatives market. If your firm uses ISDA Documentation, whether your are in Trading, Sales, Legal, Credit, Operations or any other department, its time to logon to the ISDA website.