Electronic Records of OTC Derivatives Contracts
New financial regulations, when coupled with advancing technology, will force the retention of massive electronic commerce records. Hear what the authorities are saying about the regulation of financial derivatives:
First: Famed economist Hernando de Soto says poor documentation for $1 quadrillion worth of financial derivatives is wreaking havoc on the world economy. "Toxic Assets Were Hidden Assets," Wall Street Journal, 3/25/09, pA13. He calls for much better documentation of derivatives contracts.
Second: Former SEC Chairman Harvey Pitt recommends much new record-keeping and reporting by entities like hedge funds that have not previously been regulated. “Former SEC chief says gather, share more data,” USA Today, 3/27/09 p3B.
Third: To prevent more of the “toxic” assets poisoning today’s financial system, Treasury Secretary Geithner says, “We will require that all non-standardized derivatives contracts be reported to trade repositories and be subject to robust standards for documentation and confirmation of trades, netting, collateral and margin practices, and close-out practices.”
What’s the definition of a “non-standardized derivatives contract?” It’s really just a negotiated contract that allocates risk between two or more parties. It can cover most any kind of risk or possibility, from the risk of a lawsuit to the potential for rain in the Australian Outback. (A derivative can even be "embedded" in an routine commercial contract, such as a sale agreement or a mining agreement.) The scope of this field is breathtaking. Non-standardized derivatives contracts have become a very large, thinly-monitored part of our financial world.
So what’s a complete record of one of these derivatives contracts look like? Would it be a stack of paper, stapled together, with signatures at the end? It could indeed be such a stack of paper.
But . . . let’s think deeper about how contracts are documented these days. As the methods for written business communication – letter, telex, fax, e-mail, instant message and so on -- have grown progressively more cheap and easy, the challenges for documenting complex contracts have risen.