Spoilt for choice
05 January 2021
Would securities finance and derivatives markets benefit from a consolidated master agreement? The International Swaps and Derivatives Association thinks so
Image: stock.adobe.com/SUNGYOON
Since time immemorial, securities finance and derivatives have used separate master agreements as legal frameworks to trade by, and never the twain shall meet, until now.
In 1987, The International Swaps and Derivatives Association (ISDA) produced three standard master agreements for various forms of interest rates and currency swaps, which together became the ISDA master agreement.
In the early 1990s, the International Capital Market Association (ICMA) published the global master repurchase agreement (GMRA) to aid its members in executing repos globally.
Around the same time, the International 网爆吃瓜 Lending Association (ISLA) did the same for its own members with the global master securities lending agreement (GMSLA).
Since then, all three have become the default legal frameworks for their fields. In its latest market survey of the majority of significant players in the European repo market, ICMA found that 74 percent of master agreements used by respondents for repos were written on GMRAs.
The documents have been updated several times over the years to evolve alongside the market but largely they all stayed within their original remit. The ISDA master agreement is slightly different in that it is constructed with what the association describes as an 鈥渙pen architecture鈥� meaning it allows for many types of transactions to use it, including securities financing transactions (SFTs), but, it鈥檚 still predominantly a tool for derivatives.
Now, ISDA has laid-out plans to harmonise documentation across the markets by amending its framework to more easily allow securities finance transactions to use its master agreement instead.
The three associations regularly pool their resources and collaborate in lobbying efforts to present a united front to market regulators, but on this occasion, ISDA has struck out on its own with a dedicated working group made up of its members focused on the project.
In a whitepaper 鈥� Collaboration and Standardisation Opportunities in Derivatives and SFT Markets 鈥� the trade body proposes a set of SFT-related provisions to be added to the schedule of the ISDA master agreement, along with the publication of an SFT definitional booklet.
The aim, according to ISDA, is to create 鈥渟ignificant benefits鈥� including increased operating efficiency by reducing duplicative efforts, scaling legal work and digitising/automating processes. It would also potentially reduce credit risk by facilitating collateral payment netting and expanding close-out netting sets, which could favourably impact firms鈥� capital.
Additionally, developing common standards and taxonomies would facilitate automation and interoperability across derivatives and SFT markets, and enable a consistent trade record for confirmation and reporting on a broad scale, ISDA says.
This jives with the trade body鈥檚 other major project for the year which is the further development of the common domain models (CDMs), which also seeks to standardise derivative and, in a partnership with ISLA, SFT market features and improve automation and straight-through processing.
In the whitepaper, which came out in October 2020, ISDA acknowledges the 鈥渟ignificant challenges that market participants would confront on the road to increasing collaboration and standardisation across the derivatives and SFT markets鈥�.
Moreover, the transition by a particular market segment to a newly-derived definition of a term for use across markets would need to factor in whether and how a legacy book of business can and should be migrated to the new standard, and how that might influence the adoption of the new term, ISDA adds.
ISDA notes that its claim of potential capital saving opportunities comes from feedback from individual members, not a case study or specific modelling exercise by the association to quantify the effects of a documentation switch.
鈥淲e recognise that any joint legal work would need to preserve the unique characteristics of the derivatives and SFT markets, which will require close attention,鈥� said Katherine Tew Darras, general counsel at ISDA, at the time of the paper鈥檚 release.
鈥淗owever, this proposal would result in greater efficiencies in document negotiation and management, create netting benefits to help firms reduce risk and optimise collateral use, and allow documentation updates to be rolled out consistently for different products at the same time.鈥�
Should I call my lawyers?
The question of whether the two markets would benefit from a universal master agreement is not a new one. All three associations have broached the topic with their respective members periodically but, for ISDA at least, the time to take that beyond the realm of the hypothetical is at hand.
ISDA鈥檚 senior counsel for the Americas Mark New tells SFT that the inspiration for the project may have come from its members but he does not expect or want the securities finance industry to abandon the GMSLA/GMRA formats.
鈥淲e鈥檝e been trying to channel the feedback we鈥檝e received from our members that it would be useful for them to have a tool that allows them to combine derivatives and SFTs into a single document,鈥� he says. 鈥淭hat鈥檚 not going to be the case for everyone, however, and the benefits don鈥檛 apply to all counterparties in the same way.鈥�
鈥淲e don鈥檛 have an ultimate goal of who should use this or when. Instead, we are taking our members鈥� desire to have this tool and trying to clarify the benefits of doing this as we are aware there are significant costs in launching new documentation,鈥� he states.
In contrast, ISLA says it is also in the middle of a detailed legal survey of its 120 members on the framework that underpins the industry moving forward, including asking questions on the consolidation of master agreements, but so far the responses indicate that it鈥檚 not a priority for the securities lending world.
ISLA鈥檚 CEO Andrew Dyson says: 鈥淚f you were to design a market from scratch this is not a bad idea, conceptually and intellectually, a single agreement that covers multiple products is clearly very compelling. However, we aren鈥檛 in that space and the world isn鈥檛 that straightforward.鈥�
Other industry stakeholders also argue that a one-size-fits-all document is good in theory but many are concerned the scale of the task offsets the potential benefits.
ISDA鈥檚 New also agrees that 鈥渋f you鈥檙e starting from a blank slate then it would be a no-brainer to go for a consolidated document but we鈥檙e not, so how much of the market will pick this up is unknown鈥�.
All three associations鈥� spokespersons agree that the project may be useful to some, but there isn鈥檛 a consensus on how many. Scenarios where an ISDA member that primarily deals with derivatives but wishes to expand into SFTs was offered as one example.
Alternatively, counterparties entering a new relationship may also opt for the ISDA model if it was what they were more comfortable with.
However, ICMA chief executive Martin Scheck states: 鈥淭he market is already subject to significant repapering challenges from a regulatory perspective and there simply isn鈥檛 appetite from our members to impose such an additional burden for no meaningful gain.鈥�
When asked if the three agreements could co-exist after ISDA expanded its documentation, New suggests that they could and would.
鈥淣o one expects a massive change in peoples鈥� documentation practises just because there is a new document out there,鈥� New states. 鈥淭here are benefits, such as limiting the number of legal opinions you have to manage, and there are also costs.鈥�
鈥淭here doesn鈥檛 need to be a big bang adoption. If people find it a useful tool then they can use it,鈥� he adds.
Industry stakeholders voiced concerns that the introduction of an alternative SFT master agreement goes against the grain of consolidation that鈥檚 been a primary aim of several market initiatives in recent years and risks reintroducing fragmentation. Ideally you would want want all your trades in a certain product under the same legal framework and ideally the same version of the framework, which is difficult enough.
A full plate
Sceptics of the initiative are also pointing to the fact most market participants will have their hands full juggling Brexit, potential last-minute changes to the Central 网爆吃瓜 Depositories Regulation (CSDR), the final phase of the 网爆吃瓜 Financing Transactions Regulation and the on-going pandemic, to name just a few challenges, before taking on another repapering exercise. This is especially true given the first two in the above list already represent a massive legal undertaking on their own.
Like Scheck, Dyson stipulates that the scale of the repapering task of switching to the ISDA master agreement would be 鈥渋mmense鈥�, especially without clarity on capital gains from making the switch. He further notes that the current climate is one where banks are not short of capital and are in-fact quite risk-averse.
Dyson adds that there are hundreds of entities using ISLA鈥檚 agreement and if they are comfortable that they are getting adequate legal protection for their SFTs then there will have to be quite a seismic shift to change that.
鈥淢y experience of documentation changes is that it only happens if there鈥檚 a regulatory imperative, such as with CSDR,鈥� he says.
鈥淐SDR is a nightmare of a task and you鈥檇 never do it unless you had to. Alternatively, something would have to go badly wrong with the legal construct which is unlikely with the GMSLA because it鈥檚 been around for many years and tested in court.鈥�
However, one man鈥檚 hurdle is another鈥檚 stepping stone. Part of the repapering requirement effort driven by Brexit comes from the fact EU-based entities will no longer be guaranteed protection under agreements based on English law, which includes the GMSLA and GMRA.
Here, New advances the point that regulation has the advantage of having a fixed deadline people must transition by but it is not the only thing that can lead to documentation change.
鈥淚SDA has updated its documents several times and those have been taken on through an organic process driven by two clients entering into a new relationship, for example,鈥� he says.
New states that Brexit and the introduction of final phases of the Uncleared Margin Rules which demand margin be posted for over-the-counter derivatives, could inspire firms to switch to an ISDA agreement for their SFTs, which supports French and Irish law as well as English.
As rules requiring margin or other forms of collateral continue to come into effect, ways to manage assets more efficiently will become more attractive, he adds.
Speaking of law, should securities finance market participants be concerned about whether the new agreement is as watertight as a GMSLA in court?
鈥淭here鈥檚 always a chance with these new untested master agreements that a judge might take a different view on something, such as cross-product netting, for example,鈥� Dyson observes. 鈥淭hat鈥檚 not to say the ISDA agreement or any other won鈥檛 work but until you鈥檙e sat in front of a judge you鈥檒l never really know.鈥�
New does not share this concern. 鈥淭he ISDA master agreement architecture is really open and isn鈥檛 prescriptive in the types of transactions that can be put under it,鈥� he counters. 鈥淲e are very confident that you could put an SFT under it and that wouldn鈥檛 undermine its contractual effectiveness.鈥�
Where next?
Following the whitepaper鈥檚 publication, ISDA has been in feedback mode. No fixed timeline exists for next steps and New warns that a project such as is are no small endeavour.
Once the association has digested the market鈥檚 reaction it will decide what the appropriate next steps are, he says.
Either way, if ISDA鈥檚 significant membership is driving the push for easy access into the SFT sphere, that can only be a good omen for all market participants. Whether by an ISDA or a GMSLA, all roads lead to Rome and a busy market means greater liquidity.
As such, ISDA鈥檚 project could benefit many in the market regardless of what agreement they settle on, and that鈥檚 something we can all agree on.
In 1987, The International Swaps and Derivatives Association (ISDA) produced three standard master agreements for various forms of interest rates and currency swaps, which together became the ISDA master agreement.
In the early 1990s, the International Capital Market Association (ICMA) published the global master repurchase agreement (GMRA) to aid its members in executing repos globally.
Around the same time, the International 网爆吃瓜 Lending Association (ISLA) did the same for its own members with the global master securities lending agreement (GMSLA).
Since then, all three have become the default legal frameworks for their fields. In its latest market survey of the majority of significant players in the European repo market, ICMA found that 74 percent of master agreements used by respondents for repos were written on GMRAs.
The documents have been updated several times over the years to evolve alongside the market but largely they all stayed within their original remit. The ISDA master agreement is slightly different in that it is constructed with what the association describes as an 鈥渙pen architecture鈥� meaning it allows for many types of transactions to use it, including securities financing transactions (SFTs), but, it鈥檚 still predominantly a tool for derivatives.
Now, ISDA has laid-out plans to harmonise documentation across the markets by amending its framework to more easily allow securities finance transactions to use its master agreement instead.
The three associations regularly pool their resources and collaborate in lobbying efforts to present a united front to market regulators, but on this occasion, ISDA has struck out on its own with a dedicated working group made up of its members focused on the project.
In a whitepaper 鈥� Collaboration and Standardisation Opportunities in Derivatives and SFT Markets 鈥� the trade body proposes a set of SFT-related provisions to be added to the schedule of the ISDA master agreement, along with the publication of an SFT definitional booklet.
The aim, according to ISDA, is to create 鈥渟ignificant benefits鈥� including increased operating efficiency by reducing duplicative efforts, scaling legal work and digitising/automating processes. It would also potentially reduce credit risk by facilitating collateral payment netting and expanding close-out netting sets, which could favourably impact firms鈥� capital.
Additionally, developing common standards and taxonomies would facilitate automation and interoperability across derivatives and SFT markets, and enable a consistent trade record for confirmation and reporting on a broad scale, ISDA says.
This jives with the trade body鈥檚 other major project for the year which is the further development of the common domain models (CDMs), which also seeks to standardise derivative and, in a partnership with ISLA, SFT market features and improve automation and straight-through processing.
In the whitepaper, which came out in October 2020, ISDA acknowledges the 鈥渟ignificant challenges that market participants would confront on the road to increasing collaboration and standardisation across the derivatives and SFT markets鈥�.
Moreover, the transition by a particular market segment to a newly-derived definition of a term for use across markets would need to factor in whether and how a legacy book of business can and should be migrated to the new standard, and how that might influence the adoption of the new term, ISDA adds.
ISDA notes that its claim of potential capital saving opportunities comes from feedback from individual members, not a case study or specific modelling exercise by the association to quantify the effects of a documentation switch.
鈥淲e recognise that any joint legal work would need to preserve the unique characteristics of the derivatives and SFT markets, which will require close attention,鈥� said Katherine Tew Darras, general counsel at ISDA, at the time of the paper鈥檚 release.
鈥淗owever, this proposal would result in greater efficiencies in document negotiation and management, create netting benefits to help firms reduce risk and optimise collateral use, and allow documentation updates to be rolled out consistently for different products at the same time.鈥�
Should I call my lawyers?
The question of whether the two markets would benefit from a universal master agreement is not a new one. All three associations have broached the topic with their respective members periodically but, for ISDA at least, the time to take that beyond the realm of the hypothetical is at hand.
ISDA鈥檚 senior counsel for the Americas Mark New tells SFT that the inspiration for the project may have come from its members but he does not expect or want the securities finance industry to abandon the GMSLA/GMRA formats.
鈥淲e鈥檝e been trying to channel the feedback we鈥檝e received from our members that it would be useful for them to have a tool that allows them to combine derivatives and SFTs into a single document,鈥� he says. 鈥淭hat鈥檚 not going to be the case for everyone, however, and the benefits don鈥檛 apply to all counterparties in the same way.鈥�
鈥淲e don鈥檛 have an ultimate goal of who should use this or when. Instead, we are taking our members鈥� desire to have this tool and trying to clarify the benefits of doing this as we are aware there are significant costs in launching new documentation,鈥� he states.
In contrast, ISLA says it is also in the middle of a detailed legal survey of its 120 members on the framework that underpins the industry moving forward, including asking questions on the consolidation of master agreements, but so far the responses indicate that it鈥檚 not a priority for the securities lending world.
ISLA鈥檚 CEO Andrew Dyson says: 鈥淚f you were to design a market from scratch this is not a bad idea, conceptually and intellectually, a single agreement that covers multiple products is clearly very compelling. However, we aren鈥檛 in that space and the world isn鈥檛 that straightforward.鈥�
Other industry stakeholders also argue that a one-size-fits-all document is good in theory but many are concerned the scale of the task offsets the potential benefits.
ISDA鈥檚 New also agrees that 鈥渋f you鈥檙e starting from a blank slate then it would be a no-brainer to go for a consolidated document but we鈥檙e not, so how much of the market will pick this up is unknown鈥�.
All three associations鈥� spokespersons agree that the project may be useful to some, but there isn鈥檛 a consensus on how many. Scenarios where an ISDA member that primarily deals with derivatives but wishes to expand into SFTs was offered as one example.
Alternatively, counterparties entering a new relationship may also opt for the ISDA model if it was what they were more comfortable with.
However, ICMA chief executive Martin Scheck states: 鈥淭he market is already subject to significant repapering challenges from a regulatory perspective and there simply isn鈥檛 appetite from our members to impose such an additional burden for no meaningful gain.鈥�
When asked if the three agreements could co-exist after ISDA expanded its documentation, New suggests that they could and would.
鈥淣o one expects a massive change in peoples鈥� documentation practises just because there is a new document out there,鈥� New states. 鈥淭here are benefits, such as limiting the number of legal opinions you have to manage, and there are also costs.鈥�
鈥淭here doesn鈥檛 need to be a big bang adoption. If people find it a useful tool then they can use it,鈥� he adds.
Industry stakeholders voiced concerns that the introduction of an alternative SFT master agreement goes against the grain of consolidation that鈥檚 been a primary aim of several market initiatives in recent years and risks reintroducing fragmentation. Ideally you would want want all your trades in a certain product under the same legal framework and ideally the same version of the framework, which is difficult enough.
A full plate
Sceptics of the initiative are also pointing to the fact most market participants will have their hands full juggling Brexit, potential last-minute changes to the Central 网爆吃瓜 Depositories Regulation (CSDR), the final phase of the 网爆吃瓜 Financing Transactions Regulation and the on-going pandemic, to name just a few challenges, before taking on another repapering exercise. This is especially true given the first two in the above list already represent a massive legal undertaking on their own.
Like Scheck, Dyson stipulates that the scale of the repapering task of switching to the ISDA master agreement would be 鈥渋mmense鈥�, especially without clarity on capital gains from making the switch. He further notes that the current climate is one where banks are not short of capital and are in-fact quite risk-averse.
Dyson adds that there are hundreds of entities using ISLA鈥檚 agreement and if they are comfortable that they are getting adequate legal protection for their SFTs then there will have to be quite a seismic shift to change that.
鈥淢y experience of documentation changes is that it only happens if there鈥檚 a regulatory imperative, such as with CSDR,鈥� he says.
鈥淐SDR is a nightmare of a task and you鈥檇 never do it unless you had to. Alternatively, something would have to go badly wrong with the legal construct which is unlikely with the GMSLA because it鈥檚 been around for many years and tested in court.鈥�
However, one man鈥檚 hurdle is another鈥檚 stepping stone. Part of the repapering requirement effort driven by Brexit comes from the fact EU-based entities will no longer be guaranteed protection under agreements based on English law, which includes the GMSLA and GMRA.
Here, New advances the point that regulation has the advantage of having a fixed deadline people must transition by but it is not the only thing that can lead to documentation change.
鈥淚SDA has updated its documents several times and those have been taken on through an organic process driven by two clients entering into a new relationship, for example,鈥� he says.
New states that Brexit and the introduction of final phases of the Uncleared Margin Rules which demand margin be posted for over-the-counter derivatives, could inspire firms to switch to an ISDA agreement for their SFTs, which supports French and Irish law as well as English.
As rules requiring margin or other forms of collateral continue to come into effect, ways to manage assets more efficiently will become more attractive, he adds.
Speaking of law, should securities finance market participants be concerned about whether the new agreement is as watertight as a GMSLA in court?
鈥淭here鈥檚 always a chance with these new untested master agreements that a judge might take a different view on something, such as cross-product netting, for example,鈥� Dyson observes. 鈥淭hat鈥檚 not to say the ISDA agreement or any other won鈥檛 work but until you鈥檙e sat in front of a judge you鈥檒l never really know.鈥�
New does not share this concern. 鈥淭he ISDA master agreement architecture is really open and isn鈥檛 prescriptive in the types of transactions that can be put under it,鈥� he counters. 鈥淲e are very confident that you could put an SFT under it and that wouldn鈥檛 undermine its contractual effectiveness.鈥�
Where next?
Following the whitepaper鈥檚 publication, ISDA has been in feedback mode. No fixed timeline exists for next steps and New warns that a project such as is are no small endeavour.
Once the association has digested the market鈥檚 reaction it will decide what the appropriate next steps are, he says.
Either way, if ISDA鈥檚 significant membership is driving the push for easy access into the SFT sphere, that can only be a good omen for all market participants. Whether by an ISDA or a GMSLA, all roads lead to Rome and a busy market means greater liquidity.
As such, ISDA鈥檚 project could benefit many in the market regardless of what agreement they settle on, and that鈥檚 something we can all agree on.
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