The Incumbent

For those of you in the Derivatives industry the acronym ISDA [1] immediately rings a bell. This trade association for participants in the OTC Derivatives Market provides shared standards and aims to act as a forum for investment banks to discuss industry evolution.

ISDA is particularly vigilant of market infrastructure. The banking industry, both in its Retail and Corporate incarnations, has been heavily disrupted by FinTech companies skillfully applying new technologies such as Machine Learning and Distributed Ledgers, as well as better use of other ubiquitous technologies such as Data Warehousing and APIs. The derivatives industry hasn't fallen short of considering these new opportunities.

As with any transition, the incumbent technologies and processes do not always align with what newer technologies can do. Today's mark-up language, FpML [2], will very much be a victim of this evolution as it would not take full advantage of the panoply of disruptive technologies. As an additional challenge, in lieu of a ubiquitous methodology, each firm has historically used its own representations of events and processes, minimising on the interoperability [3].

A Challenger Appears

Enter the Common Domain Model (CDM). ISDA began this project to improve the execution of simple derivatives and create an object-driven standard that could be implemented with newer technologies. This new framework would be a “common, robust, digital blueprint for how derivatives are traded and managed across the lifecycle” providing a standard “upon which existing and emerging technologies such as distributed ledgers, cloud and smart contracts can be built.” [4]

This framework breaks down products, events and programmable executables allowing for a more granular execution of trades that could be more easily programmed and managed. CDM 1.0 has been released already, and different participants in the industry are currently developing applications alongside incumbent banks, consulting firms and technology providers.

Benefits of CDM

The perceived benefits are straightforward:

  1.  Less Trade Reconciliations/Matching effort – Reduced operational expenses, consistency and efficiency.
  2.  Shared Storage/Execution per party – Less infrastructure costs, improved data storage.
  3. Platform for Smart Contracts – Leads to automation, which in turn can reduce operational expenses and consistency errors.
  4. Natively Secured – Reduces operational risk of execution.
  5.  Other interim benefits – Continued standardisation, ancillary benefits of newer technologies.

While the complexity of derivatives will most likely preclude full automation in the short term, CDM is laying the groundwork for smart contracts to fully take over the derivative market.

It seems obvious to think that if the fundamental inputs needed for these Smart Contracts would ultimately be Risk Scorecards and Liquidity Management considerations, are we far off from automating from Middle Office to Product Offering all the procedures needed to offer derivatives?

Who will be left in the trading floor?

[1] The International Swaps and Derivatives Association (ISDA)

[2] Financial products Markup Language (FpML) is a business information exchange standard built to enable OTC transactions between investment banks. Banks often provide the infrastructure, whereas SWIFT manages the open source standard. Privately negotiated derivatives also can utilise this standard for execution.

[3] ISDA Publishes Digital Iteration of the Common Domain Model (2018)

[4] Next Step to the CDM (O’Malia, 2018)