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Contractual Standards Required for Crypto Derivatives

The volatility and collapses in the crypto sector have highlighted the need for traditional market risk and  credit management, and contractual standards according to market participants.

Purvi Maniar, deputy general counsel at FalconX, and Nicola White, chief executive of B2C2 USA spoke to Scott O’Malia, chief executive of ISDA, about turbulence in crypto on the derivatives trade organisation’s podcast The Swap.Both firms have joined ISDA to help drive institutionalisation of the crypto sector.

White was named head of B2C2’s U.S. entity in May this year. She previously worked at Citadel Securities as global chief operating officer of fixed income and  was global head of electronic markets within the fixed income division at Morgan Stanley, during which time she automated interest rate trading. Crypto market maker B2C2 was founded in 2015 and is majority owned by Japanese financial group, SBI. B2C2 is headquartered in the UK, with offices in the US and Japan.

Maniar joined FalconX, a cryptocurrency and digital assets trading platform in August 2021 from HSBC where she was senior legal counsel. She has over 10 years of experience in financial services and has  previously worked at Morgan Stanley, Goldman Sachs and UBS.

The shakeout over the last few weeks has hindered the sentiment for crypto according to White, but she is encouraged by the industry coming together to find creative solutions for some of the credit exposures and losses that have occurred.

Nicola White, B2C2

“The one thing that these recent events highlight is the need to apply traditional finance concepts, and tried and tested procedures around market risk and credit management to the space, and a key item surrounding that is contractual standards,” she added.

Maniar agreed that existing traditional financial standards for market and credit risk have been shown to be useful in crypto, which will help drive institutional adoption.in the long-term

“Contractual protections are at the forefront of everybody’s mind right now,” Maniar added. “It will be quite interesting to see how they are assessed in any litigation or insolvency proceedings that we might see.”

She continued that one of the changes that has occurred due to recent events, such as the collapse of an algorithmic stablecoin and a crypto hedge fund, is to increase focus on risk management.

“We’re also seeing a lot of interest in structured solutions and clients identifying opportunities and specific strategies they would like to pursue,” she said.

White agreed that increased demand for crypto from the traditional financial firms has continued but clients are looking for changes in three areas – certainty of execution and settlement; price transparency and the ability to seamlessly transfer large risks.

“From that point of view, concepts you see in traditional finance such as transaction cost analysis become very important,” she added. “That is why you’ve seen the switch from a primarily retail-driven space that is on-exchange to an institutional space that wants to trade over the counter.”

As more institutions enter the space, White expects that trend to continue.

Standardisation

White said B2C2 has found itself spending increasing time on legal documentation and so reached out to ISDA in the second half of last year as many at the firm had come from traditional finance and knew the power of streamlined processes.

Maniar added: “Institutional investors want to see that the documentation, the contractual framework, the operational processes that have been vetted and lead to standardisation, which is tremendously important for adoption in this space.”

 Scott O’Malia, ISDA

O’Malia continued that the recent volatility makes it even more important to have a robust set of contractual standards for OTC crypto derivatives markets which is being addressed by working groups.

“I think we’ve made very good progress and most significantly we’ve convened the right people around the table to develop and think about all of these questions,” he said. “We are on track to launch a contractual framework that includes cash settled forwards and options referencing bitcoin and ether by the end of this year.”

ISDA will then move on to other products depending on the priorities of the membership.

For example, some crypto-native firms are putting collateral agreements in place which use crypto so that could be addressed, as well as counterparty documentation.

Benefits of blockchain

The biggest immediate efficiency that blockchain can impart is enabling a more real-time settlement according to White.

For example, B2C2 settles 70% of settlement requests within 15 minutes and 99% within 45 minutes, including weekends.

Purvi Maniar

“Those technical capabilities have become a real differentiator for us with our client base and something we’d love to see extended to traditional finance,” she added.

Maniar said technology can play a big part in increasing transparency in the market. She expects to see platforms such as DTCC for clearing or CLS for settling foreign exchange to develop in crypto.

“You’ll see that same type of development on this side, which I think will lead to some standardisation and a little bit less operational pain,” she added.

Over the next two years she expects to see more standardisation of tenors and settlement sources, which will be very important for growth, as well as continued interest in structured solutions.

White said that over the next two years there will be  continued widespread adoption of cryptocurrencies and blockchain technologies.

“One of the things that I’m really excited to see is the traditional finance space and crypto space come together,” she added.