The ISDA 2021 Interest Rate Derivatives Definitions: A New Era of Digitisation

Over the last couple of years, we have become accustomed to seeing generational events happen: a President being impeached for the second time, drive-in cinemas coming back into vogue and the discovery of murder hornets. 

However, for derivatives lawyers, 2021 will usher in an equally notable – albeit less publicised – event: for the first time in 15 years we will be able to reference a new ISDA interest rates definitions book. We have seen significant changes in the industry since the 2006 ISDA Definitions that these replace. When these were published, there will have been partners reading this who were trainees or junior associates; Italy was the World Cup Champion and Google had just purchased a nascent competitor – YouTube – for $1.65b (ok, some things don’t change). Likewise, since 2006 the derivatives space has seen a number of large-scale changes to market structure, regulation, tech and market practices which have meant that over time ISDA has published 76 supplements to keep the 2006 ISDA Definitions current and relevant – not even the Beckhams have been able to keep themselves that relevant for that long! 

Stephan Werthauer (Consultant), together with Akber Datoo (CEO) of D2 Legal Technology (D2LT) outlines why the ISDA 2021 Definitions booklet marks an important moment in the digitisation agenda of the derivatives industry.

Why change?

Given the average daily turnover of the derivatives market being c$6.5t, it is hugely important that the standard terms for the interest rate derivatives trades is current and accurate. Therefore, the 2021 Definitions booklet has been designed to consolidate all of these supplements into the main book as well as modernising it, in order to bring the booklet into line with current market practice. ISDA’s aim is to ensure that the booklet is more robust, more user-friendly and more accessible for digital consumption and use. For those more tech-focused, this also has some exciting implications for ISDA’s wider digitisation agenda. 

It has become apparent across the derivatives space that current working practices cannot scale at the same rate as the growth in the derivatives industry. As such, the continued direction of travel is a conscious attempt to better integrate derivatives infrastructure with documentation practices. This has been underpinned by foundational industry initiatives such as the Common Domain Model (CDM) – a blueprint for how derivatives are traded and managed across the trade lifecycle.  Having a single, common digital representation of derivatives trade events and actions seeks to enhance consistency and facilitate interoperability across firms and platforms, providing a foundation upon which new technologies can be applied.  The fact that sections of the 2021 Definitions will be included in the CDM is an important step in this regard.  It is also aligned to the work to digitise the relationship-level documentation, through the ISDA clause taxonomy and library that D2LT were engaged by ISDA to design. This standardises the way in which one defines clauses contained in these agreements, as well as being able to tie business outcomes in the documentation to the wording itself.  So, between the 2021 Definitions (which primarily operate at the trade level), and the Clause Taxonomy and Library (which operates at the master agreement level), there is excellent progress being made to standardise – a crucial step for any automation through systems and platforms.

ISDA has also announced that the 2021 Definitions will be published on its ISDA Online Library which is both indicative and facilitative of this digitisation agenda. This library has, moreover, enhanced search functions, comparative tools and easy to navigate indexes. 

Further, in order to avoid future requirements for new interest rate definitional booklets to be published and then subsequently adopted and integrated into market participants’ documents, ISDA has committed to update and maintain this booklet online and re-publish the book in its entirety every time a change is made.  This will ensure that any future updates are included by incorporation rather than supplementation, reducing the likelihood that the industry will require a new booklet in 15 years. Could this potentially be the last and definitive set of definitions? 

When will it change?

ISDA published the 2021 Definitions on the 17th May 2021, with an implementation date of the 4th October for clearing houses, trading venues and other market users. As such, Monday 4th October marks the day when these definitions can be used as standard. 

ISDA has confirmed that the 2006 definitions will continue to exist; however, following the implementation weekend, the 2006 definitions will no longer be updated or maintained. This in mind, users of these definitions are encouraged to embrace change and adopt the 2021 definitions as soon as practicably possible in order to benefit from future evolutions of the definitions. 

What’s changing? 

The changes are focused on:

 

Change Change made
Cash settlement methodologies Certain methodologies for determining a cash settlement amount

following early termination or swaption exercise will be replaced with more robust methods that reflect changes in market conventions over the past 15 years – such as the increased use of collateral, the use of XVAs in valuations and the shift to overnight index swap discounting.

Floating rate options Floating rate options will be transposed from a narrative format into a grid or matrix structure. This will make them more standardised and easier to read, process and update. The matrix format will divide different types of floating rate options into standardised categories with a common naming convention to enhance predictability and allow integration with trading systems.
Payment and calculation provisions Terms relating to the payment of floating amounts will be updated

in the 2021 Definitions, with the addition of new business day

calendars and conventions. For example, the concept of ‘unscheduled holiday’ will enable certain dates (such as payment dates) to shift to the next good business day when there is insufficient notice of a market closure/holiday. Wherever possible, inputs required to make calculations under the 2021 Definitions (such as day-count fractions and interpolation) will be set out as formulae rather than narrative.

Calculation Agent provisions The 2021 Definitions will specify that whenever the calculation agent is required to act or make a determination, it shall do so in good faith using commercially reasonable procedures to produce

a commercially reasonable result. This is the same standard used for the close-out provisions of the 2002 ISDA Master Agreement.

Introduction of generic fallbacks Although floating rate options with specific fallbacks for index

cessation events2 will continue to fall back under those provisions,

many floating rate options do not have such specific arrangements.

The 2021 Definitions will set out a generic framework that will

allow parties to work towards identifying a fallback rate and any

adjustment. It will also introduce a trigger in case law or regulation

prevents one of the parties from being permitted to use the relevant floating rate option, called an administrator/benchmark event

Means of publication and amendment of the definitions The 2021 Definitions will be published in a purely electronic

format through a new interactive web-based user interface. Instead of issuing supplements, any changes will be made by publishing a new version of the 2021 Definitions in full.

This new interactive format will include comparison tools that

allow different versions of the definitions to be viewed in blackline. Versions will be differentiated by version numbers and dates of publication.

 

How to I adopt these changes?

The relevant ISDA working groups are currently in discussion ascertaining what the easiest method of adoption would be the best for conversion of legacy 2006 definitions into 2021 definitions. 

It is likely that this will be via a protocol, however, no final decision has been made at the time of writing. Market participants and functions involving valuation, tax, accounting, margining and clearing are encouraged to think through the impact of conversion in their respective areas. 

Fundamentally, these innovations mark a significant moment for the management and application of derivatives definitions. This further step forward in the digitisation agenda underpins ISDA’s founding goal of making the global derivatives market safe and more efficient; it is important that market participants prepare themselves accordingly ahead of the implementation date and seek to realise the benefits of these foundational digital steps.

About Lisa Baker, Editor 2419 Articles
Lisa Baker is the Editor of Always Finance, and writes about Business, Finance Technology and Healthcare. Lisa is also the owner of Need to See IT Publishing.