The Definitions aim to support the safe and efficient development of the digital asset derivatives market through consistent contractual standards.
On January 26, 2023, the International Swaps and Derivatives Association, Inc. (ISDA) published version 1.0 of the long-awaited ISDA Digital Asset Derivatives Definitions (the Definitions), intended to create “an unambiguous contractual framework for digital asset derivatives under the umbrella of the ISDA Master Agreement.” Latham & Watkins LLP was pleased to participate in the development of the Definitions as part of a working group of sell-side and buy-side market participants and digital asset legal advisors.
ISDA Chief Executive Scott O’Malia highlighted the importance of the Definitions in light of the recent crypto market failures, noting that they provide a “clear, consistent contractual framework that spells out the rights and obligations of both parties following a default.” ISDA concurrently published a companion Settlement Price Source Matrix and forms of Digital Asset Confirmations intended for use for non-deliverable forwards (NDFs) and non-deliverable options (NDOs).
ISDA also published the first of two whitepapers exploring the legal questions that emerged from the recent tumult in the crypto space. The first whitepaper, Navigating Bankruptcy in Digital Asset Markets: Netting and Collateral Enforceability, explores the legal and property characterization issues that exist for digital assets. It also confirms that ISDA will begin work in 2023 to update netting opinions in the relevant jurisdictions to cover digital assets. The second paper will focus on issues related to customer assets held with intermediaries and should be published later in Q1 of 2023.
As formulated in the current release, the Definitions are designed for privately negotiated NDFs and NDOs referencing Bitcoin or Ether. The Definitions are meant to address the unique features and characteristics of digital assets (such as forks, diversity of liquidity providers, and varying approaches to price sources) and may be amended and expanded over time as they are relevant to other digital asset transactions conducted via distributed ledger technology, including tokenized securities.
The Definitions are drafted in a modular structure, and cover, among other things:
- product types and settlement terms;
- disruption events and fallbacks, including disruption events that market participants are familiar with from other asset classes (such as price source and hedging disruption, and change in law disruption) as well as a new disruption event relating to forks; and
- additional termination event terms.
A section on valuation methodology is reserved for future buildout, as the current iteration only considers transactions referencing one settlement price source, valuation date, and valuation time.
Notably, the Definitions have been drafted “using a controlled language structure to define the processes contained in the document, facilitating integration with the [ISDA] Common Domain Model and automation within smart contracts.” In other words,
- key operative provisions employ conditional logic (IF/THEN statements); and
- conditions refer to various elections that can be triggered in the transaction confirmation.
All or part of the Definitions may be incorporated into a document (or part of a document) in connection with a digital asset transaction. ISDA advises, however, that because laws and regulations regarding digital assets are still evolving, parties to a transaction should consider all applicable regulatory, tax, accounting, or other requirements.
Counterparties to transactions that do not involve NDFs or NDOs referencing Bitcoin or Ether should also be mindful of the Definitions’ current scope before employing them in documentation. For example, technology and market infrastructure considerations such as “airdrops” and “staking” are not included in the Definitions under “Disruption Events” but may be relevant to digital asset transactions other than NDFs/NDOs referencing Bitcoin or Ether. Similarly, digital asset transactions that are physically delivered are not addressed in the current suite of documents. However, these considerations may be on the docket for future publications as the digital asset derivatives market continues to grow and evolve.
ISDA’s publication of the Definitions is an important step in support of improved customer protection and risk mitigation in the digital asset derivatives market. From a practical implementation perspective for legal practitioners, given the multi-jurisdictional legal and regulatory framework of digital assets and its continually evolving state, market participants should consult with their legal advisors in incorporating the framework into their documentation.