What’s up with the docs? Isda aims to set standard for crypto

Industry body looks to standardise digital derivatives documents, but some wonder if it is best placed to do so

  • With more institutional firms entering the crypto derivatives sphere, and the market coming under greater regulatory scrutiny, the International Swaps and Derivatives Association is looking to introduce standardised documentation for bilateral contracts.
  • Many crypto-native firms are happy to maintain the status quo and continue adapting Isda’s old documents to govern their trades.
  • Others welcome standardisation, but question whether Isda is best placed to deal with the evolving space and say crypto-native firms should be playing a greater role in the discussion.
  • The association faces a challenge in building documentation that will exist in harmony with its existing legal documentation framework.

When Larry Tesler died in 2020, computer users across the world mourned a scientist who had made their lives a whole lot simpler. His most celebrated innovations were the “cut”, “copy” and “paste” functions that allow text to be duplicated across multiple documents. And some of the most avid users of those functions can currently be found in the world of crypto derivatives.

It all started when crypto-native firms began looking into trading over-the-counter derivatives and realised they had a problem: there was no crypto-specific legal documentation to govern the bilateral relationships between counterparties.

A few institutional traders, seeing the opportunities in crypto assets, had a solution. It involved cutting and pasting elements of the International Swaps and Derivatives Association’s existing master agreements to fit bilateral crypto derivative trades – or even copying and pasting the documentation wholesale. Some traders also use amended elements of Isda’s other documents – such as the definitions for foreign exchange, equities or commodities – in their own documentation.

“It’s widely available; you can just buy it from Isda,” says Max Boonen, founder of crypto market maker B2C2. “Everyone who has been more than 10 years in finance probably has a copy on their USB stick somewhere.”

Rob Strebel, head of relationship management at another crypto market maker, DRW, says his firm is using Isda’s 2002 documentation, “and from what I’ve seen, others are doing the same”.

Mark New, Isda’s senior counsel for the Americas, says the association has no problem with the ways its documents are being used. “Isda produces template documents to help firms put documentation in place,” he says. “Markets can operate more efficiently by adopting Isda-published standards. But if firms want to amend documentation to their bespoke versions, they are free to do that.

“The Isda documentation sits within a broader contractual framework, which is the Isda master agreement, and that helps parties manage their counterparty credit risk. It’s also supported by a large library of netting opinions, so that give parties comfort.”

However, New adds that, for efficiency’s sake, it would be better to move to new standards for crypto trades, and it is for this reason that Isda is developing specific documentation for OTC crypto derivatives. The association aims to release a first tranche of boilerplate contracts this year, covering the most basic crypto derivatives.

Amended versions of Isda’s master agreements have been widely circulated, and have undergone further modifications to make them applicable to crypto-specific issues as such issues have arisen. However, using amended Isda documents could cause problems further down the road. When a firm amends the association’s documentation for a bilateral trade using Isda’s equity definitions, and then does the same trade with a different firm but this time using a variation of the FX definitions, there is a discrepancy between the two trades.

Josh Lim, head of derivatives at crypto market maker Genesis, says: “As a dealer, we’re going to try to enforce the same sort of terms on every agreement or contract that we enter into, because we don’t want hedging discrepancies.”

Standards deviation

The development of exchange traded crypto derivatives, such as CME’s bitcoin futures, has helped the OTC market by providing participants with benchmarks and enabling them to hedge themselves. Since CME launched its bitcoin futures contract, the average volume of contracts traded daily has grown from 1,056 in December 2017 to 7,659 last month.

Yet many believe the lack of documentation standards has been a barrier to the OTC market’s growth. Although crypto-native firms and some banks have traded non-deliverable forwards linked to crypto – trades that have been settled in US dollars – the market has yet to take off. DRW’s Strebel believes having standardised Isda documentation would help to address this issue.

“For the sake of crypto becoming more of a mainstream asset class, it’s important that it’s treated the same way as all these other asset classes,” he says. “Isda is the dominant form of documentation in fixed income, equities, FX. I think it should also be the dominant documentation within crypto so that there’s some uniformity across all these asset classes, and consistency, and so that it’s easier for accounts to trade cross-asset and there’s comfort in the security around that.”



Since crypto emerged, Isda has taken an interest in developing related standards, and the association reached out to some crypto-native firms when the asset class’s first derivatives were being traded. In December, its working group published a white paper fleshing out some of the most prominent concerns over how OTC crypto derivatives were being documented and what might need to change.

Ciaran McGonagle, assistant general counsel at Isda Europe, says: “We spoke with a number of Isda members to try and understand how traditional financial institutions in the first instance were engaging with this market, given it is increasing in size so rapidly.”

At least four crypto-native firms are Isda members: B2C2, the FTX US and Coinbase exchanges, and DRW. No other finance industry associations have thus far been involved in the association’s work on this subject.

“We are definitely seeing interest from crypto firms,” says New. “We have had a few firms join Isda recently from more of the crypto world, which I think is certainly driven by interest in the work that we want to do here.”

Many agree that standardisation would be welcome. However, in a rapidly evolving market, and with Isda’s membership mostly based in the traditional institutional space, some in the digital assets space wonder if the organisation is best placed to deal with the crypto-specific issues that would need to be addressed.

“Crypto is, by design, something that’s a little bit decentralised,” says Lim. “So, we organically reach consensus through the exchange of these documents.” He believes the market as a whole is in a better place to do this than Isda.

Genesis is among the firms whose leaders fear the association will miss the mark unless more crypto-native companies become involved in the push to standardise documentation. “The outcome of the Isda working group is really going to be dictated by the banks for the most part,” says Lim. “Most of the innovation is really happening at non-bank institutions and dealing desks and crypto-native trading firms, most of which are sort of prop trading firms. It’s going to be very hard for anything that a working group comes up with to keep pace with the innovation of the asset class.”

Although an Isda member, B2C2 has come up with its own bilateral agreements, partly because its non-institutional clients have required more lightweight documentation. “A lot of people don’t like to sign Isda’s [documentation] in crypto,” says Boonen. “They think it’s too complicated. A lot of clients actually prefer to sign a more sort of bespoke, crypto-centric agreement.”

Taking a long position

McGonagle and New acknowledge that creating standardised documents will be a long process and say Isda is determined to get the standards right first time. This will mean beginning with the most fundamental products in crypto derivatives. The working group aims to develop a transaction template that will sit below the overarching master agreement and cater for the most common types of cash-settled transactions, such as those referencing bitcoin and ether, while looking at benchmarks from regulated exchanges.

“We’re obviously going to confirm that remains the case and those are the transaction types the market wants us to address by way of contractual standards, at least this year,” says McGonagle.

According to Isda’s white paper, the goal in 2023 will be to build on that work by looking at more complex digital assets and at products such as perpetual swaps, along with physical settlement. The working group also hopes to have a full definitional booklet or library completed by then.

“We have this opportunity to create something correct the first time,” says DRW’s Strebel. “So it’s important to go product by product, and we can start with the simple stuff like options and NDFs. Then we can add complexity as we figure out the basic building blocks of this documentation.”

Most OTC crypto derivative trades have been cash settled rather than “physically” settled, primarily because of regulations – relating to anti-money laundering, prudential treatment and tax – and because of concerns around custody risk and custody costs.

With so many products that might reasonably be described as “digital assets” entering the market, Isda’s working group has decided not to come up with its own definition. Instead, it will be up to the counterparties to determine whether such a term is appropriate for their transactions.

Authorities across the world have also taken a keen interest in developing appropriate regulations for crypto markets and are assessing the risks for institutional firms. Isda’s white paper states that, for certain digital assets, today’s unregulated market might “create valuation issues or heighten disruption risks”.

Knives out for the forks

Isda’s primary focus will be understanding the substantive issues around crypto derivatives that will need to be addressed within its existing documentation. However, there are other, crypto-specific issues it will also need to address.

One such issue is the potential for “forks” – where a blockchain splits from its original chain, and shares the information from the original chain but goes in a separate direction. A “soft fork” might take place when there has been a minor software update to the blockchain; a “hard fork” would require all users to upgrade to the latest version and would mark a permanent divergence from the original chain.

When a fork occurs, trading venues, custodians and index providers have to decide which chain to support. There could be challenges if that decision is not unanimous, particularly if the index provider chooses a different path from the others. This could alter the value of the digital assets, and clear documentation would be needed to determine any valuation adjustments.

Another crypto-specific issue is the “airdrop”. This is where a business promoting a new cryptocurrency sends coins or tokens to holders of other compatible digital assets, which could change the market value of the assets. Isda’s working group will be trying to understand when and if firms should price an airdrop into a derivative contract.

Any standardised documentation will also have to take into account the possibility of a cyberattack and any consequent impact on a digital asset’s value or observed price. Furthermore, traditional derivatives use screen rates, trading venue data, published index prices and internal modelling as valuation sources. However, more decentralised indices and new valuation sources are coming to the fore in digital assets, and counterparties will need to take these into consideration in their documentation framework.

Additionally, there are questions around when a trade executed on a blockchain actually settles. Many blockchains rely on emergent consensus mechanisms, under which there is no fixed point in time at which a transaction is considered final. Instead, transactions become increasingly unlikely to be unwound as the blocks they are in become more embedded in the ledger. On bitcoin’s blockchain, for example, a transaction is considered irrevocable from a practical perspective after six blocks have been built on it, which usually takes around an hour.

“There are certain distinct features of the crypto markets, as compared with more traditional markets, that may warrant special consideration in a derivatives contract,” says Sophia Le Vesconte, senior associate at law firm Linklaters. “For example, the fact that you don’t have one primary trading venue, and you often get price discrepancies between different trading venues; the fact that the markets are open 24/7, which might mean you don’t have predictable liquidity patterns; or the fact that novel technological events, like forks and airdrops, could have a fundamental impact on valuation or settlement.”

It is also unclear how existing financial regulations apply to certain digital assets. As the sector develops, an ongoing point of discussion will be whether clearing houses, counterparties or regulators would consider stablecoins or central bank-backed digital currencies as eligible collateral for margin purposes.

Some believe having standardised crypto-specific documentation would make institutions more comfortable about moving into this largely unregulated space. DRW’s Strebel says: “As crypto develops and we see it becoming more sophisticated, more complex – and as we pull in institutional accounts that have certain expectations and a way of doing business and certain comforts, and security needs, around the products that they trade – it’s important to standardise this.”

Isda envisages gradual change rather than any overnight shift. “The idea is that the documents we produce will evolve over time,” says McGonagle. “We will need to ensure that when we’re dealing with new types of transaction or new types of digital asset, the standards can evolve in line with market developments and technological developments.”

The association is working on legal guidelines for smart derivatives contracts with the aim of building a smart contract code that would be capable of calculating daily credit exposures and posting collateral. “We acknowledge there is a need for documentation for this market to be compatible with the technological infrastructure that supports the digital assets markets,” says McGonagle. “So, I’m talking about blockchain and smart contracts. Any kind of documentation that we produce should, of course, not only be digital but should be capable of supporting and interacting with smart contracts and blockchain architecture.”

In the brave new world of crypto derivatives, a cut-and-paste approach may no longer be enough.

Update, May 3, 2022: This story has been updated to include a chart with daily volumes of CME's bitcoin futures.

Editing by Daniel Blackburn

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