German credit institutions DZ Bank and BayernLB have traded an over-the-counter (OTC) interest rate derivative as a digital smart derivative contract (SDC), the first time this has been completed according to the two counterparties.
The trading parties handled the full lifecycle of the OTC derivative transaction over a number of days through an automated and legally-binding process, demonstrating that such a trade can be delivered digitally.
The transaction was completed using distributed ledger technology (DLT), with Eurex Clearing, Deutsche Börse’s central counterparty (CCP) service, acting as neutral account manager for credit exposures from this non-cleared OTC derivative transaction.
Successful completion of this interest rate derivative trade confirmed the advantages of smart derivative contracts, according to the project participants. Market value for the transaction is calculated using a valuation model agreed in the derivative contract and outstanding obligations are settled through automated booking on a daily basis.
Smart derivative contracts offer protection against credit risk, they note, with automatic contract termination being enacted if a counterparty cannot meet their settlement obligations. Moreover, the trial indicates that DLT technology provides an efficient mechanism for verifying transaction data, for minimising reconciliation challenges and for supporting automated settlement of counterparty obligations.
The project was implemented in collaboration with the Ludwig Maximillan University of Munich and law firm Jones Day. Project participants now intend to conduct OTC derivative trades with a wider set of market participants, including buy-side firms.
DZ BANK board member for capital markets Wolfgang Köhler, says: “The successful trial of the smart derivative contract shows how we can develop efficient and innovative capital market products with the help of new technologies.”
“We are making an important contribution to the digitalisation, homogenisation and automation of settlement processes of OTC derivatives on the capital market and the project creates opportunities to reduce regulatory costs,” adds Köhler.
Jens Hachmeister, Deutsche Börse’s head of issuance and new digital markets, says: “DLT-based solutions are suitable for significantly improving the security and efficiency of products and processes on the capital market - especially in the off-exchange area. Smart derivative contracts and automated payment settlement via DLT are promising use cases here. As a neutral account manager, Deutsche Börse also ensures trust and efficiency in the decentralised financial markets.”
