ISDA published a paper that discusses legal aspects of smart derivatives contracts that use the distributed ledger technology (DLT), which is also commonly known as the blockchain technology. The paper identifies specific private international law issues with respect to contract law that may arise when trading derivatives in a DLT environment. Where appropriate, the paper proposes recommendations on potential ways to clarify or resolve these issues.
DLT systems are often borderless, allowing multiple users or participants to modify records in a shared database that may be based in several jurisdictions without necessarily needing to use a central validation system that imposes its own standards and processes. This type of system may leave participants vulnerable to multiple—and potentially inconsistent—assertions of the governing law. The cross-border nature of derivatives transactions requires certainty in the application of law to avoid conflict-of-law issues from arising. The introduction of new parties (that is, a platform provider) to the trading relationship creates additional legal rights and obligations, some of which may be governed by laws that are different from those by which the trading documentation is governed. Understanding the precise situs (that is, where property is treated as being located for legal purposes) of assets delivered or exchanged is important when determining the enforceability of netting or collateral arrangements. To assist with practical discussion of the relevant issues, this paper discusses two different examples of derivatives transactions, both of which use ISDA documentation and are implemented on Corda, an open-source blockchain and smart contract platform developed by R3.
The paper has considered a number of private international law, or conflict-of-law, aspects of derivatives contracts governed by the laws of Singapore and England and Wales and involving DLT. Considering the most straightforward implementations of both an uncollateralized and collateralized DLT transaction, it is not thought likely that either implementation would result in an English or Singaporean court disapplying an express choice of law, whether in the ISDA Master Agreement or any agreement between the parties and a platform provider. The paper recommends that it would provide for greater clarity for all parties if they agree that their transactions should be subject to a common "law of the platform," "law of the system," or elective situs—that is, a uniform choice of law that the parties agree will govern all on-ledger transactions. Such common law of the platform could then be used as the situs of any tokens that are native to that DLT system.
Where national authorities and regulators are concerned that allowing parties an unfettered choice of a governing law of the platform is undesirable, the choice of law could be restricted to the laws of countries where parties such as the issuer of assets, the system administrator, and market participants are subject to sufficient legal and regulatory oversight. Were this approach to be adopted, the primary concern of the parties would then be whether a court order requiring one party to compensate another could be obtained and whether it would be enforced. As considered earlier in this paper, the functionality of DLT platforms such as Corda could assist with the practical enforcement of judgments. Establishing this system will require national governments, judiciaries, regulators, and international standards-setting bodies to work on adapting or developing global legal standards aimed at ensuring the safe, transparent, and consistent regulation of DLT-based financial transactions and to ensure that parties are unable to elect for their relationships to be governed by the laws of countries with inadequate policy, legal, or regulatory oversight.
Keywords: International, Banking, Insurance, Securities, Distributed Ledger Technology, Blockchain, Fintech, Regtech, Smart Contracts, Derivatives, ISDA
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