Although price machinations of various bitcoins have dominated the business press over the last several years, one of the lesser known implications of the worldwide interest in blockchain and distributed ledger technology (DLT) is the possible use of smart contracts (SCs) in the derivatives market – and in the rates space in particular.
According to new TABB Group research, “Getting Smart about Smart Contracts in Rates,” SCs’ potential for making the rates swaps business more efficient looks very attractive, but these contracts and the processing arrangements they require imply changes in almost every aspect of the swaps business, for just about every kind of participant. “In other words,” says George Bollenbacher, TABB head of fixed income research who wrote the report, ““we need to get a lot smarter about SCs in the rates swap market before we can go much further.”
Like many blockchain efforts, SCs have been talked about, tested, and even hyped for a while. The question now is whether and when they will become commonplace and ordinary. Two aspects of rates derivatives that make SCs both desirable and difficult to implement are the uncertain path of any rates derivative from inception to extinguishment and the continuing drive to create new and more profitable instruments.
However, he explains there are four conditions that will dictate the future of SCs in the rates market, the first being standardizing as many of the instrument and event descriptions as possible. ISDA’s CDM is a prominent effort in this area, and it has the admirable characteristic of relying on parameters for definition, as opposed to names. What the CDM recognizes is that any instrument or event with the same parameters is the same thing, no matter what it’s called, but tiny changes in one of those parameters means that we have a different instrument or event, even if the name hasn’t changed.
Although SCs do appear to hold several of advantages for rates derivatives and some progress has been made toward effective, widespread implementation, Bollenbacher says “there’s a lot of work to be done. With the support of ISDA and certain large-market participants, the outlook is promising.” But, he warns, “getting to the Promised Land is always a trek, and this case is no different.”
“Getting Smart about Smart Contracts in Rates” is available for immediate download by TABB fixed income and derivatives clients and pre-qualified media at https://research.tabbgroup.com/search/grid. For more information or to purchase the report, write to info@tabbgroup.com.
