Legal Issues On Using Smart Contracts on DLT Reviewed

The International Swaps and Derivatives Association, Inc. (ISDA), Clifford Chance, R3 and the Singapore Academy of Law have published a new whitepaper that provides analysis on the legal issues relating to the use of smart derivatives contracts on distributed ledger technology (DLT).

DLT and smart contracts have the potential to significantly increase efficiency and automation in the derivatives market. However, the perceived lack of legal certainty when trading derivatives on a DLT platform could hamper broad-scale adoption.

While certain jurisdictions have published or are developing their own legal analysis on some of these issues, the use of DLT in a global, cross-border context raises a number of questions from a private international law perspective that are important to the derivatives industry.

Given the inherent uncertainty about where data, assets and even counterparties are located in a DLT environment, a key question is how to determine which law applies to these relationships and assets, and what should happen when there are conflicts of governing law.

The paper provides an introduction on some of the critical issues, including:

Choice of law and enforceability: The paper explores whether the introduction of DLT or the involvement of a platform provider in a typical trading relationship affects the parties’ choice of law or how contractual disputes are resolved. This is critically important to derivatives market participants, as an unexpected change in applicable law could undermine certainty and the legal enforceability of netting and collateral arrangements.

The analysis concludes it is unlikely an English or Singaporean court would disapply an express choice of law by the contracting parties, whether under ISDA documentation or in any other agreement between the parties and a platform provider.

Digital assets: The paper also considers use of digital assets for payments or exchanging collateral on certain DLT platforms. The analysis recognizes challenges in identifying the precise location of digital assets, which could lead to uncertainty over which jurisdiction’s laws would apply.

In response, the paper recommends that, where these issues exist, parties are permitted to agree on a common ‘law of the platform’ – a uniform choice of law that the parties agree will govern all transactions conducted on the DLT platform.

“DLT offers a great opportunity to reduce inefficiencies and increase automation in the derivatives market, but a number of legal issues need to be addressed to fully realize this potential. This paper provides greater certainty to participants using DLT for derivatives, and helps the industry move a step closer to the operational and cost efficiencies that greater automation will provide,” said Scott O’Malia, ISDA Chief Executive.

“This paper marks an important step by ISDA in raising the legal issues relating to the use of DLT in derivatives and to highlight the interplay between these issues. These questions relating to DLT are different from smart contracts and can be more complex, particularly in the context of netting and collateral for derivatives transactions,” said Paul Landless, Partner and Co-Head of Tech Group, Clifford Chance.

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