ISDA to Publish Draft Standards for Crypto Derivatives by Year End

ISDA will also consider developing collateral documentation for OTC crypto derivatives transactions and standard contracts for crypto swaps and physically-settled transactions.

ISDA (International Swaps and Derivatives Association) is planning to publish its initial set of standards and definitions for the OTC crypto derivatives market by the end of this year.

The industry body established a working group last year to develop uniform legal standards and definitions for crypto derivatives. In December, it published a whitepaper exploring key issues the working group is seeking to address with the new standards. This work will ultimately produce a framework for handling cyber attacks, forks, airdrops, and valuation issues that are unique to crypto derivatives markets.

“The recent extreme volatility in this asset class [crypto] has brought some important questions to the fore,” said ISDA chief Scott O’Malia, speaking at the Japan Derivatives Forum on Tuesday (15 November). “Among the most important is what rights investors have in the event of a bankruptcy of a crypto exchange or wallet provider. At the moment, the answer is not always entirely clear.”

In light of the recent collapse of crypto exchange FTX, O’Malia emphasised the importance of having a clear, consistent contractual framework that spells out the rights and obligations of both parties following a default. He said ISDA wants to bring the same legal certainty that exists in other derivatives asset classes to the OTC crypto derivatives market.

Until now, institutions have largely traded crypto asset derivatives using amended versions of existing ISDA definitions and templates (for instance, ISDA’s equity or FX definitions) or using their own bespoke documentation. This leads to a lack of standardisation and means certain unique events that occur in crypto assets markets, like forks and airdrops, are not directly covered by the documentation.

“Working with members from both the crypto and traditional finance sectors, we’re well advanced in producing standard terms for cash-settled forwards and options referencing Bitcoin and Ether,” O’Malia said, adding that the initial set of definitions are due to be published before the end of the year.

ISDA will then consider extending this work to include the development of collateral documentation for OTC crypto derivatives markets, as well as contractual standards for other product types such as swaps and physically-settled transactions.

In his remarks, O’Malia also noted that ISDA is still also working to ensure a risk-appropriate capital framework is adopted by the BCBS (Basel Committee on Banking Supervision) as it progress efforts to finalise its framework on the prudential treatment of bank exposures to crypto assets.

The BCBS standards are also due to be finalised by year-end, following consultations issued in June 2021 and June 2022. The proposed framework includes a 1,250 percent risk weight for crypto assets such as bitcoin, an exposure limit that would cap banks’ total exposures based on their capital, and an infrastructure risk add-on to account for risks associated with DLT.

O’Malia said the second consultation made some “important improvements”, but that the proposed framework remains “unnecessarily conservative and would hamper the ability of banks to meet customer demand for intermediation in crypto exposures”.

ISDA has recommended changes to try and achieve a framework that is more risk appropriate.

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