The International Swaps and Derivatives Association (ISDA) has updated an annex to its master derivatives agreement to support the use of tokenized collateral.
This step is important for the adoption of tokenization because of the massive size of the derivatives markets. The notional value of global derivatives is more than $700 trillion, although the gross market value is around $20 trillion.
Typically derivatives agreements require the parties to post margin, which can vary over time.
Margin conventionally takes the form of bank balances, physical securities certificates, or assets held at a depository or custodian. ISDA has added clauses to support DLT-based cash and DLT securities.
However, this tokenized collateral is only usable if ownership changes recorded on the distributed ledger “result in a legally effective transfer of the relevant right or interest to the recipient or its agent.” That’s because not all tokenizations are sufficiently legally binding.
One of the key operational differences between blockchains versus banks and conventional securities is it’s usually possible to transfer tokens 24/7 outside of operating hours. However, ISDA’s credit annex specifies a ‘local business day’. So ISDA defines that as a day when the system for delivery (the blockchain or DLT) and commercial banks are open for business.
Understandably, ISDA added caveats around the legal enforceability of the new clauses as well as the potential for other regulatory tax and accounting issues.
Meanwhile, for years ISDA has been very active in progressing the adoption of DLT and crypto-assets. While the Common Domain Model (CDM) wasn’t specifically designed for blockchain, the standardization of derivatives data and processes made the model perfect for DLT solutions.
ISDA has also explored the legal enforceability of DLT-based derivatives. Plus, it weighed in on the debate around Basel rules for banks using crypto-assets and hedging in particular.
