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Achieving Smart Contract Management in OTC Derivatives Trading with Mindtree’s Blockchain SolutionSecure + Reliable + Fast Processing
In the capital markets, some risks are better managed through customizable, over-the-counter (OTC) contracts rather than through exchange-traded financial instruments. But what happens when OTC contracts themselves create the risks?
Over-the-counter (OTC) derivative transactions allow counterparties added degrees of flexibility and privacy. Yet OTC transactions are subject to specific risks of data entry errors, data leaks and unauthorized changes, making them more expensive
Stepping Through a TransactionTo illustrate the functionality with Smart Contract Management, suppose “Customer” wants to buy from “Trader” a forward contract with a notional value of USD $2M with a settlement date in 30 days.
Even though this example is among the simplest possible OTC transactions, it already involves numerous steps as well as multiple organizations throughout the clearing and settlement process. With the legacy
to manage and execute, and more difficult to track for internal audit or external compliance purposes. Until recently, these inefficiencies and risks were considered part of the cost of doing business. The counterparties to an OTC transaction had to be extremely careful, building in extensive checks, cross-checks and error resolution processes into an extremely complex workflow.
For OTC contracts, documentation – including text, photos, videos and voice confirmations – is essential. If
there’s a dispute at any point during the lifecycle of an OTC transaction, it’s the quality and extent of documentation that will determine the outcome. That’s why counterparties entering into an OTC agreement must agree not only on terms and conditions, but also on a shared approach for sharing and protecting the underlying documents. OTC documentation is also required for regulatory purposes, including the Dodd-Frank Act in the U.S. and capital requirements under the Basel standards.
One of the simplest use cases, and consequently the area where initial development has been most focused, is with OTC derivatives contracts such as forward contracts on currencies. With these contracts, the amounts and timings are fully customizable to meet the needs of customers, and the underlying asset is a currency, which by definition is highly liquid and well understood.
Blockchain Solution for Smart Contract Management
Mindtree’s Blockchain-based solution enables a new, smarter approach to OTC contract management. Using a distributed shared ledger based on Blockchain technology, banks can deploy a faster, more efficient and more secure solution for the trusted and transparent
exchange of documentation related to an OTC transaction, including:
Real-time, error-free document transmission and sharing
Data security that maintains the privacy of transactions
Protection against data manipulation
Rapid retrieval of contract data for dispute resolution
Efficient auditing with measurement of execution quality
The securities industry is moving toward the use of Blockchain for exchanging documentation related to OTC transactions. A distributed shared ledger delivers a common solution for all participants in OTC transactions, including banks (market maker) and their customers (Buyer/Seller), clearing members, CCPs and DTCC.
approach to OTC transactions, such a trade may have been agreed to on the telephone, with documents following by fax or instant message. For many organizations, the various documents were maintained using manual, paper-intensive processes, with each step requiring further bilateral processes. Any breakdown in these processes could lead to an expensive dispute resolution process.
A Blockchain enabled distributed shared ledger condenses the time between steps for all of the counterparties, and simplifies the entire process for:
Trade Initiation and Negotiation: Bilateral exchange of information related to requests for quotes, signing of ISDA Master Agreement, collateral requirements and standard settlement instructions
Trade Execution and Confirmation: Updating both parties with trade execution status and confirmation
Trade Termination: Processing requests for termination according to agreements
Trade Settlement and Warehousing: Processing settlement instructions, reporting of net settlement instructions, multi-lateral settlement, trade settlement confirmation and trade affirmation
QuantityTraders and customers can trust the Blockchain-based distributed shared ledger for high-value transactions.
Derivative Quotation ResponseInteractions between traders and customers, including digital signatures of audio, video and images, are permanently and irrevocably stored on the Blockchain, providing an accurate record with a complete audit trail.
Accept | RejectSmart Contract Management using Blockchain technology allows contracts to be negotiated within a secure environment.
Trading in OTC derivatives through a distributed shared ledger creates numerous efficiencies in trade initiation, execution, settlement and warehousing.
Stepping Through a TransactionTo illustrate the functionality with Smart Contract Management, suppose “Customer” wants to buy from “Trader” a forward contract with a notional value of USD $2M with a settlement date in 30 days.
Even though this example is among the simplest possible OTC transactions, it already involves numerous steps as well as multiple organizations throughout the clearing and settlement process. With the legacy
Overall Benefits of Smart Contract Management At the highest level, Smart Contract Management builds trust in OTC contracts using the improved security, transparency and efficiency by distributed ledger:
Security: Encrypts and validates transaction details using cryptographically-secure methods
Maintains the legitimacy of information associated with a trade, including customer information
Reduces opportunities for fraud
Transparency: Seamless integration across multiple systems
Simplifies data exchange between multiple entities
Provides a single source of accurate data for use throughout clearing and settlement
Efficiency: Facilitates easy document storage and retrieval
approach to OTC transactions, such a trade may have been agreed to on the telephone, with documents following by fax or instant message. For many organizations, the various documents were maintained using manual, paper-intensive processes, with each step requiring further bilateral processes. Any breakdown in these processes could lead to an expensive dispute resolution process.
A Blockchain enabled distributed shared ledger condenses the time between steps for all of the counterparties, and simplifies the entire process for:
Trade Initiation and Negotiation: Bilateral exchange of information related to requests for quotes, signing of ISDA Master Agreement, collateral requirements and standard settlement instructions
Trade Execution and Confirmation: Updating both parties with trade execution status and confirmation
Trade Termination: Processing requests for termination according to agreements
Trade Settlement and Warehousing: Processing settlement instructions, reporting of net settlement instructions, multi-lateral settlement, trade settlement confirmation and trade affirmation
Eliminates unnecessary workflows
Quickly resolves disputes by reducing errors and discrepancies
Smart Contract Management makes banks more effective at serving the needs of their customers, whether in terms of lowering the cost of transactions, improving execution quality, and fostering an environment of trust between customers and traders through the use of transactions that are less likely to fail.
Making the leap to distributed shared ledgersIn order to unlock these substantial benefits, financial institutions first need to address the fundamentals of working with distributed shared ledgers. This does require a significant one-time effort for organizations to assign each participant with a secure, unique identity; to establish nodes on an integrated Blockchain network; and to assign participants to network nodes as required.
Mindtree supports financial institutions during this essential transition in several ways, both for the CTO and for the lines of business.
Customer requests a quote from a trader.
The request is stored on the distributed shared ledger.
Trader receives the quote and is prompted to give a response.
Customer and Trader negotiate a rate through an iterative process.
Customer accepts the trade at a mutually agreed price, and then initiates standard settlement instructions
Trader accepts the terms and conditions, and then executes the trade.
Customer reviews the details of the contract, and at this stage, still has the opportunity to terminate the contract for specified reasons
Once both sides have posted collateral as appropriate for the trade, the OTC contract goes to settlement.
Trader sees the details of the contract, with confirmation of settlement.
Administrators can review the status of the distributed shared ledger, including current blockchain size and recent transactions.
Details of recent transactions can be used to ensure transaction integrity for auditing purposes.
Trade initiation Trade execution Trade settlement Trade warehousing
For the CTOMindtree provides a fully tested solution for joining a distributed shared ledger, which saves the CTO from having to ramp up on the steep learning curve required to the intricacies and hands-on details of Blockchain technology. With industry-grade software builds made available through cloud or on premise deployment, the Mindtree solution is easy to maintain and provides simple connectivity options to existing core systems.
Services include: Analysis for Blockchain solution deployment and support, with consideration of development, testing, maintenance and training Access to a highly qualified team of Blockchain experts Tested approaches for migration to distributed ledgers, including integration with legacy solutions. Best practices for risk management, security, archiving and rollback Evaluation of implications on IT architecture
In addition, Mindtree offers the CTO: Direct access to trusted experts in banking and financial services
Customizations for firm-specific workflows and IT architectures
Proof-of-concept demonstrations to gain stakeholder buy-in
Fully-functional apps built by our performance-driven development labs
Management of third-party implementation partners
For the Business HeadMindtree provides an extensive set of services to support leaders in derivatives markets, investment banking and capital investment during the transition to Smart Contract Management with distributed shared ledgers.
The introduction of Smart Contract Management reshapes the basis of competition in the industry. By eliminating unnecessary intermediaries, reducing process time, banks will be able to provide better services at lower cost, with fewer process failures and reduced risks. These changes accrue largely to the benefit of banks, who have the strongest relationships with their customers.
Mindtree works with Heads of Business in financial institutions on:
Addressing regulatory compliance requirements with distributed shared ledgers Advice on how shared ledgers, Blockchain applications and smart contracts best fit to your business requirements Strategic roadmaps for adopting distributed ledger technology
The Future of Distributed LedgersBlockchain technology promises tremendous benefits to be realized throughout the industry. Using a shared, distributed ledger, all entities involved with a transaction will be able to access trade and settlement data in real time, while also having the ability to manage risks with maximum efficiency.
OTC derivative transactions represent an excellent starting point for banks wishing to get started with the technology. The transactions are relatively simple compared to transactions involving more complex financial instruments, and there is a high demand for customization in terms of currency pairs, pricing and settlement dates.
By simplifying the contracting, clearing and settlement processes for OTC derivatives, banks have the opportunity to reduce costs and improve services for their customers. Over time, the financial services industry will be able to expand OTC derivatives to a wider customer base, supporting lower contract values at higher volumes and greater flexibility. This will enable the expansion of risk management to new areas, supporting future generations with stronger economic growth.
About MindtreeMindtree [NSE: MINDTREE] delivers digital transformation and technology services from ideation to execution, enabling Global 2000 clients to outperform the competition. “Born digita l,” Mindtree takes an agile, collaborative approach to creating customized solutions across the digital value chain. A t the same time, our deep expertise in infrastructure and applications management helps optimize your IT into a strategic asset. Whether you need to differentiate your company, reinvent business functions or accelerate revenue growth, we ca n get you there. Visit www.mindtree.com to learn more.
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Overall Benefits of Smart Contract Management At the highest level, Smart Contract Management builds trust in OTC contracts using the improved security, transparency and efficiency by distributed ledger:
Security: Encrypts and validates transaction details using cryptographically-secure methods
Maintains the legitimacy of information associated with a trade, including customer information
Reduces opportunities for fraud
Transparency: Seamless integration across multiple systems
Simplifies data exchange between multiple entities
Provides a single source of accurate data for use throughout clearing and settlement
Efficiency: Facilitates easy document storage and retrieval
Eliminates unnecessary workflows
Quickly resolves disputes by reducing errors and discrepancies
Smart Contract Management makes banks more effective at serving the needs of their customers, whether in terms of lowering the cost of transactions, improving execution quality, and fostering an environment of trust between customers and traders through the use of transactions that are less likely to fail.
Making the leap to distributed shared ledgersIn order to unlock these substantial benefits, financial institutions first need to address the fundamentals of working with distributed shared ledgers. This does require a significant one-time effort for organizations to assign each participant with a secure, unique identity; to establish nodes on an integrated Blockchain network; and to assign participants to network nodes as required.
Mindtree supports financial institutions during this essential transition in several ways, both for the CTO and for the lines of business.
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