The Financial Stability Board (FSB) and its chairman, Mark Carney, last month reiterated their intention to prioritize central counterparty (CCP) resilience, recovery and resolution for the remainder of 2016. They are absolutely right to focus on this issue. Several clearing houses have become systemically important as a result of global clearing mandates, and it’s vital this infrastructure is as secure as possible – which means establishing a credible and robust recovery and resolution framework.

This isn’t a new topic, of course. Considerable thought has gone into this at both the regulatory and industry level over the past few years – and ISDA has published several papers on the issue (here’s our most recent). But the thinking is continually evolving, particularly on the issue of resolution. An important recent consideration has been when and how recovery becomes resolution – in other words, at what point should resolution authorities step in, and what tools will be available to them?

It’s a crucially important issue. At ISDA, we recognize there may be situations where a resolution authority has to intervene before CCP-led recovery efforts have fully run their course. That might include circumstances where it is felt the recovery measures set out in the CCP rule book would further increase systemic risk or lead to contagion. But, if resolution authorities elect to enter a CCP into resolution, we believe it is important to abide by certain conditions to maximize certainty and predictability and maintain market confidence.

In particular, we recommend that resolution authorities, should they intervene, follow the rules and the tools defined in the CCP rule book. ISDA has already set out a proposed recovery framework, which includes a variety of loss-allocation and position-allocation tools and the sequence of their use, aimed at providing maximum predictability of outcomes. We recommend this framework be adopted in CCP rule books, approved by regulators and followed by resolution authorities. By following this transparent rule book, a resolution authority would provide comfort to market participants and minimize market disruption, as well as ensure the concept of ‘no credit worse off’ – a central element of the ISDA recovery framework – is applied.

Careful thought should also be given to the point of entry. ISDA believes recovery should be CCP-led as far as possible, but if that is not possible, the indicators for a resolution authority intervention should be defined upfront. Clarity over the entry point would, again, help provide certainty about the process.

It’s important, though, that these triggers aren’t automatically applied. For instance, it’s possible one of the conditions for intervention might be failure by the CCP to achieve a matched book. However, it’s also possible the problem is limited to a small subset of illiquid products. In that case, it might be preferable for the CCP to implement position-allocation tools for that subset, such as partial tear-up, rather than trigger resolution of the entire CCP.

There’s another important element to all of this. Whether through recovery or resolution, clearing participants should be compensated for any losses incurred through loss-allocation or position-allocation tools, over and above the CCP’s funded and unfunded default resources. This emulates the outcome that would be achieved if clearing participants were to go through an insolvency process.

All of this comes back to CCP resiliency. Ensuring CCPs are strong to begin with minimizes the prospect of a recovery or resolution action. That’s why the measures outlined in our paper on CCP resilience – transparency, stress testing, appropriate skin in the game, monitoring of concentration risk and scrutiny of suitability of products for clearing – are vital.

In making these proposals, ISDA is continuing in its long-standing role of ensuring legal and contractual certainty for industry participants, and in helping to build reliable and transparent procedures to deal with periods of market stress. Both the FSB and European regulatory authorities are due to publish further proposals on CCP soundness in the coming months, and ISDA will continue to engage with its membership, the wider industry and all relevant regulatory institutions to ensure the best solution on this issue.

Speak to anyone who knows a thing or two about the infrastructure that the modern world is built on – roads, rail, power generation and supply, etc – and they will tell you that often the biggest obstacle to its improvement is the ‘legacy’ issue. Once a system is in place, built at great cost and effort, transitioning to improved technology can be challenging.

This is a headache that the derivatives market now faces. Much of the infrastructure used in the handling of data, the processing of documentation, the execution and confirmation of trades and the exchange and management of collateral, is over-complex, needlessly duplicative and inconsistent.

Let’s face it – old systems were developed for old problems. With the financial reforms at various stages of implementation, our members are looking for new solutions to automate and streamline the massive reporting, trading and clearing requirements and new collateral management requirements in the derivatives space. To support our members and address the operational challenges and complexity head on, ISDA itself has reorganized its working groups to focus on developing solutions for critical infrastructures that are now embedded in the fabric of the derivatives market. For instance, we see tremendous potential to move collateral management from faxes, email and Excel spreadsheets to a more automated and streamlined process.

ISDA is in an ideal place to help guide this change. At our core, we are a standards body. We have brought the market together to establish the ISDA Master Agreement and the ubiquitous Credit Support Annex (CSA). Today, we are leading the market to bring a standardized approach to non-cleared margin rules with the ISDA Standard Initial Margin Model (SIMM). We are developing new CSAs to comply with the updated segregation requirements, and we are putting together a globally-applied resolution stay protocol to harmonize resolution regimes. Looking ahead, there is an opportunity to future-proof the legal documentation process through smart contracts, and to develop industry operational standards to facilitate the processing of trades throughout the trade lifecycle. Additionally, so much more can be done to modernize and upgrade the process by which we exchange collateral by driving standardization and automated efficiency.

ISDA has canvassed its members on these issues, and turned their proposals into a whitepaper that will lay out some proposed steps toward reform. We have been engaging with members and fintech / regtech firms to identify problems and recommend solutions. To give you a preview, our paper will focus on three specific areas.

• Data: Agreement on formats and identifiers would significantly benefit market participants and regulators. In particular, a robust, granular, multi-use product identifier with strong governance on an open-source infrastructure would remove many systemic inefficiencies and further promote transparency.

• Documentation: Despite a plethora of standard documents published for industry use, it is an unfortunate fact that many documents are still customized between transacting parties. The benefits of this customization are now being questioned, and there are opportunities for further standardization to drive more efficient processing, both within firms and across the market. We are committed to future-proofing the essential ISDA documentation through ‘smart contracts’ that will facilitate the automation strategies being developed by distributed ledger and block chain firms. ISDA has a lot to offer to speed the adoption in this space.

• Duplication: There is a huge opportunity to cut down on the complexity and multiplicity of business processes required to support the same functions within or across asset classes. Standard processing models can facilitate the extension of Financial products Markup Language (FpML) in order to remove cost and inefficiency and provide a solid base for further evolution.

This isn’t about levelling existing infrastructure and starting from scratch. It is about finding a more efficient, less costly way of operating vital processes, and making sure that new, beneficial technology can be brought to bear without adding further burdens to an already over-stressed system.

ISDA will continue to encourage and facilitate discussion on these issues among traditional and new operators in the derivatives market. Our membership is exceptionally broad, and our door is always open to new firms and new ideas. This is a challenge that will be overcome, above all, by cooperation and collaboration, and ISDA will always provide a platform for this to take place.