ISDA and UCL researchers examine smart derivatives contracts

High-value derivatives contracts require substantial legal protection and often utilize standardized legal documentation provided by the International Swaps and Derivatives Association (ISDA). Smart Derivatives Contracts aim to automate many aspects of high-value contracts, including automation of the provisions of the ISDA legal documentation.

Researchers Christopher Clack from the Centre for Blockchain Technologies, Department of Computer Science, University College London, and Ciar´an McGonagle from ISDA investigate how the ISDA Master Agreement may affect the automation of payments and deliveries: they provide a framework for understanding how high-value derivatives contracts are structured at different levels, in terms of both the legal documentation and the workflow; they explain issues relating to how the smart contract code processes payments-related and deliveries-related events; and they discuss the extent to which these are amenable to automation.

Summary and conclusion:

Smart Derivatives Contracts aim to automate high-value derivatives contracts, including automation of aspects of the Master Agreement as well as automation of lifecycle events stated in the economic terms of the specific derivatives product. This vision raises many issues to be solved, such as
(i) how the smart contract code can be faithful to the legal agreement, and
(ii) to what extent the provisions of the legal agreement can be automated.

This requires an interdisciplinary approach that brings together computer scientists, lawyers and banking practitioners. Much of the operational detail of payments and deliveries can be found in the transaction confirmation and product definitions (i.e. the economic terms and payment mechanics of the particular derivatives product).

However it is not sufficient just to automate the operational aspects of the contract found in the economic terms; the broader contractual relationship must also be taken into account in order to capture the complexity that can affect a party’s ability to perform its obligations (or assert its rights) and in order to support key operations such as netting that are expressed in the Master Agreement.

Developing smart contract code for deployment on a distributed ledger is a specialist function, requiring experienced technology practitioners and computer scientist, and the need for low-level ISDA CDM functions to be fully validated in advance so that they can be utilized when developing the smart contract code.

In the light of this specialist nature (and complexity), and in order to ensure that the code is faithful to the legal contract, they have explained that it is essential for development to be a co-operative effort involving (at least) the skills and experience of banking technology practitioners, legal professionals and computer scientists: to address the legal context of the operations that are being automated; to ensure that the code is compatible with the relevant commercial, regulatory and legal standards; and to ensure that the code is consistent with the way that the parties wish to conduct their financial transactions.

Read the full academic paper

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