Oct 30, 2015

The legal profession time to embrace the digital era?

Hippopotomonstrosesquippedaliophobia is a fear of long words, arachnophobia is a fear of spiders, and machroreadaphobia is a fear of machine-readable text. This last one is not a real phobia, although it is more common than most people realise and affects many in the legal profession. However, the true cause of this affliction frequently stems from a misconstrued notion of what machine-readable text actually is. The advances in digital technology are recasting everything around the needs of the user. Users expect access to data immediately to make decisions. The legal profession is not insulated from this change.

So what is machine-readable text?

Machine-readable text allows a document, contract or agreement (any text per se) to be read by a machine so that the data within the document can be extracted, transformed and subsequently processed by machines. It allows standard representation of the terms within a document to be captured, processed, digitised and stored, producing an output that enables all users of the information to easily access the information at any time.

So what are the benefits of machine-readable text?

One of the most integral benefits of machine-readable text is that at times of market crisis – when timely access to the information stored within legal contracts is critical – the information contained within legal documents is available at the click of a button. Information such as “Additional Events of Termination”, “Downgrade Ratings linked to Termination Events”, “Automatic Early Termination”, can all be identified in seconds rather than the hours, or days, it currently takes legal departments to identify this information.

Standard representation of legal terms using machine-readable text is undeniably value-add, that many industries could leverage, but the impetus right now is for it to be accepted uniformly across the financial services sector. It would help identify inconsistencies within documentation and improve transparency, aiding both the parties to these documents as well as their regulators. With all the modern technology available in the market place (offered by various tech providers), legal departments are in a better position than ever before to have a clear and efficient way to create, store and present documents and data to their two main internal stakeholders – trading desks and credit departments.

 So why is there a reluctance to accept the technology?

Simply put, the issue resides with the word standard. Legal departments (lawyers and negotiators similarly) have an inherent dislike – for good reason, for standardisation. Financial institutions rely on their lawyers and negotiators to draft their legal documentation that will seek to mitigate risk and protect their interests for all of their trading relationships. Despite standardised templates (the likes of which are provided by International Swaps and Derivatives Association – ISDA, International Capital Market Association – ICMA, International Securities Management Association – ISMA, etc.), lawyers and negotiators will continue to draft bespoke language and client specific wording to mitigate risks.

However, while legal departments have always and will continue to need the flexibility to adjust the standard terms of the agreements, there no longer seems to be a logical argument as to why all historic and current documentation cannot be converted into machine-readable text for a standard representation of terms.

Bridging the gap – technology and legal

The processes that technology and operations providers perform and those that lawyers perform differ less than many believe.

Technology and operations providers collate data; use an algorithm to process the data, which creates an output, still in data form. For example, transaction agreements; trade data is captured into systems as machine-readable text; it is then processed via an automated system algorithm; the resultant output is then fed in data and machine-readable form to consumers, i.e. risk management to use in their process.

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Lawyers also begin with data – in so far as they know the required information that will need to be documented in order to protect their financial institution; they then process the data mentally to create the right output; the resultant output is then a human-readable document that is sent to the other party for legal negotiation. The final output is a human-readable signed legal document binding both parties.

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There are three identical steps – input > process > output. The difference is the form of the output – machine-readable versus human-readable.

One goal delivery of information to mitigate risk

Given the number and type of potential consumers of data contained in documents, machine-readable output is efficient, scalable and ultimately more consumable. Legal agreements contain all the information that a financial institution relies upon to mitigate its risk with a counterparty with which it holds a trading relationship. Transaction agreements have embraced the machine-readable era through electronic confirmations. This has provided real-time transparency to both parties to a trade including the regulatory authorities, without necessarily standardising the terms of these transactions. Relationship agreements managed and negotiated by legal departments have not.

PDFs (Portable Document Format) or TIFFs (Tagged Imaged File Format) are elec
tronic copies of the paper legal relationship agreements but are not automatically machine-readable. Moreover, these agreements are often stored in shared folders, personal drives and occasionally on email, adding to the complexity of even knowing where to look to understand what terms have been negotiated. At times of crisis, when time is of the essence, the need to have the information contained within these agreements at your fingertips is critical. Having to search through a PDF or a TIFF is slow, frustrating, and a once in time exercise, needing to be manually repeated every time a new crisis occurs.

Lawyers and negotiators leave roles, teams change, and the trail of paper is not always as smoothly transitioned, as it should be. Yet with the ability to digitise past, present and future documentation, why, when prompted under times of market stress, trawl through many documents, in various locations, to search for the relevant information, when the data can be extracted, transformed and processed as and when each agreement is signed and / or amended?

So what next for the legal industry?

In the digital age, machine-readable text is the logical next step. Digitisation and machine-readable text doesn’t mean standardised terms or the end of negotiations or the end of legal departments. If anything, digitisation removes the burden previously placed on legal departments and allows them to focus on their true areas of expertise, mitigating the risks to their firms.

With the Basel Committee on Banking Supervision (BCBS) and the Board of International Organization of Securities Commission (IOSCO) having set new rules to manage counterparty risk and margin requirements for un-cleared derivatives, now is the time for technology and legal to make an accord on machine-readable text. Regardless of how this latest regulation plays out in terms of implementation, more pressure will be placed upon legal departments everywhere to mitigate risk at a much faster and cost effective pace. So legal departments should, no must, embrace the digital era.