2020 VISION: TRANSFORMING THE LEGAL DOCUMENTATION LANDSCAPE THROUGH STRUCTURED DATA

Jason Pugh, Managing Director, D2 Legal Technology

 

The derivatives industry has been transformed by the proactive engagement of its members over the last 30+ years, an exemplar of bright, resourceful individuals coming together to achieve business outcomes that benefit the industry as a whole. From pioneering the master agreement, the eye-catching creation of protocols, to harmonisation of business process through the likes of FpML, the industry has constantly evolved.

Today, the industry is facing new challenges and while many will consider, correctly, that the proliferation of global and regional regulations since the financial crisis has both been challenging and led to unintended consequences, there is an even more stark reality that players in this market need to consider, i.e. surviving in a disrupted universe.

 

Jason Pugh, Managing Director, D2 Legal Technology, outlines the potential that can be achieved by enhancing legal data standards and how that this is an essential precondition to fundamentally transforming the operating environment through technology.

 

We all witness the impact of Uber and Amazon in every walk of life which has extended client expectations. We all know that as clients appreciate and come to expect these new capabilities and services, disrupted technology will not be put back into the bottle.

Similarly, clients in the financial services industry rightly expect more for less. It may also be less complex than we fear – the industry is, after all, not as unique as it likes to think and a vast proportion of our business can be commoditised.

The critical challenge for the industry is therefore to transform itself into a cheaper and better risk managed operation that achieves the twin goals of client satisfaction and regulatory compliance – this means simplification, the current framework is too complex comprising too many disparate processes pieced together in a makeshift manner.

The correlation between better client service, better risk management/compliance and cost efficiency is high when viewed through the prism of effective front to back processes. This is the challenge the industry faces, and the good news is that many of the strands are already being developed; the challenge is to bring them together.

 

The journey so far

Over these last decades, ISDA has worked with its members and market participants to produce and maintain a documentation framework. It has constantly responded to market changes and this has led to an evolution of its suite of documentation especially with the development of the ISDA Master Agreement and associated documentation, such as various annexes, definitional booklets and protocols. This framework has provided important legal certainty, clarity and efficiency for market participants and critically transformed the credit risk profile of trading entities through the concept of close-out netting.

In recent years, the number of standard form documents and their complexity has proliferated often in response to regulatory requirements. Many of the core terms have remained constant, yet there has been an ever-increasing number of variants in the specific clauses used within the documentation framework, increasing the time taken for negotiation and onboarding of new client relationships.  These increased variances have different commercial and operational effects and have precipitated multiple bespoke business processes to monitor, at a time when monitoring has been more scrutinised than ever, post financial crisis.

The increased cost of supporting pre- and post-trade activities and complying with the new regulatory obligations, alongside reduced profit margins in the derivatives business, is not sustainable. Against a backdrop of an increasingly digital and data-driven world, there is a need and an opportunity to standardise and digitise the legal documentation.

Through the adoption of common market standards, the market will be able to leverage technology-enabled contract delivery and management solutions, as well as allow the use of technology such as Distributed Ledger Technology (DLT) and smart derivatives contracts.

Significant work has progressed in these areas through the work of ISDA and others and there is a broader recognition of the need for market infrastructure, utilities, data governance, documentation change and process change. However, there is more to be done and until recently, legal agreement clause/data standardisation and legal agreement data had been at the periphery of current legal technology initiatives. But it is now falling into the mainstream, with clause taxonomies which are designed to address the growth of clause variants into one singular vernacular. Most importantly, we have seen the development of an outcomes based approach where variants are being condensed if they relate to the same business outcome. This is foundational when looking to enhance process, reduce risk and meet client expectations.

 

A glimpse of what “strategic state” looks like

Historically, written legal agreements have been king as we look to document and evidence the intention of trading parties, which has been largely effective. However, the legal profession has, on occasion, complicated contracts through verbose legalese that is not even consistent with the prose of other lawyers and incomprehensible to the uninitiated – never mind those e.g. in operations, giving effect and managing the risks arising from the contractual obligations they create.

The environment has changed and in an increasingly data-driven world, it is no longer the written word that is king. Firms are moving to operationalise their businesses through automated data-driven processes, and accordingly, key commercial and operational terms, as well as risks monitored within legal agreements need to form a part of the business process if they are to play a part in optimising the business decision-making, management of commercial risks and operations. However, until the key data elements of the legal agreements are structured, transparent and consumable, this optimisation is impossible. This means defining standard structured data variables and allowable values for those defined variables.

 

It all starts with structured data

We are on an inevitable journey to data-orientated legal agreements, with a representation of the written contractual terms in a manner that follows a consistent, predictable and structured data format. There are numerous tangible benefits to data orientated contracts, such as enhancing the process of negotiating legal agreements, allowing the opportunity to automate the creation and delivery of legal agreement documentation, and negotiate and execute it with multiple counterparties simultaneously, by focusing on intended business outcomes.

By having a standard list of variants focusing on outcomes of those clauses, it is possible to utilise LegalTech solutions to parse through legacy legal agreement documentation, and classify the clauses contained within such documentation against those standards and successfully manage those contractual obligations to optimise the business.

 

Challenges on the road to delivery

Markets and industries, by their very nature, tend to resist new ideas, products and standards. Added to this is the sheer amount of change to the pre- and post-trade processing and market infrastructure landscape in OTC derivatives following the 2008 financial crisis.

However, to unlock the benefits of the changing legal documentation landscape, the focus needs to be on data. Firms have historically under-invested in core reference data, and whilst there have been marked improvements, the standard is lacking for legal contract data; firms are simply unable to systematically understand the risks emanating from their broad contractual portfolio.

Clause taxonomies create a framework in which to work with legal agreements and manage the contractual obligations they contain, allowing classification to be conducted within the framework of that taxonomy. Although taxonomies are a well-established approach to categorising and linking to business processes, these have only been used to a limited extent by market participants for legal agreement management, and typically created individually (often for a particular department or specific use within a firm). They do however, form the foundations of optimising value from business processes and unlocking value through (legal) change.

 

Conclusion

Market participants have demonstrated considerable pioneering spirit to develop the industry through legal documentation. It now needs to be bold enough to take the next step to unlocking the digital agenda by developing common data standards. There are times when firms should compete and there are times when they should converge for the common good – and this in one of them.

Structured data will enable technology to provide the insights clients require with a far simpler and more sustainable operating model. We therefore need to think smart and adapt to operate in this new landscape which we should embrace, rather than resist.

 

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