New international definitions to improve enforcement on digital asset derivative transactions

ISDA’s digital assets derivatives definitions document is designed for use in transactions governed by the ISDA Master Agreement, which is the most widely used master service agreement for over-the-counter (OTC) derivatives transactions internationally. The definitions are designed as “a consistent set of global contractual standards” which will provide “an unambiguous contractual framework” to help parties reduce credit and market risk in the fast-growing and evolving crypto sector, the organisation said.

The definitions initially cover non-deliverable forwards and options relating to bitcoin or ether, but could be expanded in future to include additional product types, such as tokenised securities and other digital assets executed on distributed ledger technology (DLT).

Financial services expert Tom Bicknell of Pinsent Masons commented: “ISDA’s approach to defining digital assets as settled on DLT allows for flexibility of scope over time. The conditional statements are drafted in a way that allows for them to be used within the smart contracts settlement coding.”

A key feature of the new definitions highlighted by the ISDA, is the “controlled language structure” it has used to define the processes contained in the document. This method of drafting should facilitate integration with ISDA’s standardised, machine-readable Common Domain Model (CDM) technology and allow for automation within smart contracts.

The definitions also contain default provisions addressing some terms common to digital asset transactions. For example, the disruption event fallback provisions cover the so-called “fork disruptions” that are unique to blockchain digital assets. These provisions set out the consequences on digital asset derivative transactions if a “protocol change” results in two or more digital assets branching from the original blockchain being available for trading.

At the same time as publishing the definitions, the ISDA published a report (25-page / 156KB PDF) addressing some of the biggest legal issues raised by the recent bankruptcies of major crypto exchanges and market participants, including the November 2022 collapse of FTX.

According to ISDA, ‘netting’ and ‘collateral’ are two of the most effective methods of credit risk protection within ISDA documentation. Its report focuses on the importance of close-out netting and collateral arrangements for derivatives referencing digital assets, as well as pointing out the gaps in national insolvency law and regulations over the enforceability of such arrangements in different jurisdictions if a counterparty, such as a crypto exchange, defaults.

“In light of recent high-profile bankruptcies, the creation of a standardised set of definitions provides much needed clarity around netting and collateral enforcement for digital asset transactions,” said Bicknell.

ISDA intends to publish a second report focusing on issues relating to digital assets held with intermediaries.