January 26, 2023 International Swaps and Derivatives Association, Inc. (ISDA) has released version 1.0 of the long-awaited definitions of ISDA digital asset derivatives (Definitions). The primary purpose of these guidelines is to create "a clear contractual framework for digital asset derivatives under the ISDA Master Agreement guidelines."
ISDA Director General Scott O'Malia stressed the importance of the definition in light of the recent numerous failures in the crypto market, noting that the latest regulations provide "a clear and consistent contractual framework that defines the rights and obligations of both parties in the event of a default of contractual obligations." . ISDA has additionally published an accompanying Settlement Price Source Matrix as well as digital asset confirmation forms for use in non-deliverable forwards (NDFs), and additionally in non-deliverable options (NDOs).
At the same time, ISDA also published the first of two previously announced white papers addressing the legal issues that have arisen as a result of recent events in the crypto space. The first whitepaper, Navigating Bankruptcy in Digital Asset Markets: Netting and Collateral Enforceability, addresses the legal issues and accompanying characteristics of cryptocurrency ownership that exist in the realm of digital assets. The document also clearly states that ISDA will begin efforts in 2023 to update the netting opinion in the relevant jurisdictions to include digital assets in the scope of regulation. The second document will cover issues related to customers' digital assets that are stored with intermediaries. The publication of this document should take place at the stage of the first quarter of 2023.
As set out in the current edition, the Definitions are intended for privately negotiated NDFs and NDOs relating to cryptocurrencies such as Bitcoin or Ether. The definitions are intended to take into account the unique characteristics and parameters of digital assets (such as forks, variety of liquidity providers, and different approaches to price sources). It should be pointed out at this point that Definitions related to the crypto market may be changed and extended over time, as they are relevant to other factors and transactions related to digital assets that are transferred via distributed ledger technology, including primarily tokenized securities.
The definitions have a modular structure and mainly include:
- Types of products, as well as billing conditions;
- Industry disruptive events and emergencies, including disruptive events known to market participants from other financial asset classes (such as, for example, price and collateral disruption and regulatory change issues), as well as an additional cryptocurrency fork disruption event;
- Characteristic additional terms related to digital assets. The section on valuation methodology points to the future development of legal regulations, as the current iteration includes only transactions relating to one source of settlement price, valuation date and time of valuation.
It is worth noting at this point that the definitions were produced "using a controlled language structure to define the procedures contained in the latest document, facilitating integration with the [ISDA] common domain model and automation within smart contracts."
All or part of the Definitions may be included in a document (or part of a document) related to individual digital asset transactions. However, the ISDA advises that because the laws and regulations surrounding crypto assets are constantly evolving, all parties to a transaction should consider any applicable regulatory, tax, accounting or other requirements at all times.
Counterparties to a transaction that does not include a Bitcoin or Ethereum-related NDF or NDO should also be mindful of the current scope of the Definitions before applying them in specific documentation. For example, technology and market infrastructure related issues such as "airdrops" or "staking" are not covered by the definitions under "Disruptive Events" but may be relevant to transactions other than NDF/NDO related to Bitcoin or Ether. Additionally, digital asset transactions that are physically delivered are not included in the current set of documents. There is nothing stopping these considerations from being included in future publications as the digital asset derivatives market continues to grow and evolve towards the future.
The publication of the Definition by ISDA is an extremely important step in the development of more effective customer protection and mitigation of risk in the digital asset derivatives market. From the perspective of the practical implementation of the Definition, given the legal and regulatory framework of digital assets spanning many jurisdictions around the world and its constantly evolving state, digital currency market participants should consult with their legal advisors to incorporate this framework into their transaction documentation.
