Legal Data Lenses: Review Of Legal Data For Banking By Akber Detoo

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Legal Data for Banking by Akber Detoo perfectly illustrates how the boosting of regulations in the aftermath the 2007–2008 Financial Crisis highlighted deficiencies in the legal data management.

Here I post some valuable conclusions I derived from that book.

Data Oceans

• Data is not just an IT issue

Understand data from the perspective of business intelligence one can derive from it.

• Legal data — legal agreements and legal opinions data — is not just a legal department’s issue

Many regulations and instruments in the financial sector — like BCBS 239 requirements — have strong legal data components.

Imperfect World

• Legal data is a significant problem area in the financial context

The author claims that in many cases–

1. much of the legal data is significantly unstructured — i.e. not stored in a predefined manner
2. converting from unstructured data to structured data can be difficult and costly
3. search by document name, or across the raw text of the documents, is often of little use for business decision-making
4. legal data lack defined ownership
5. issues of unintended uses of legal data arise frequently, and
6. legal data suffer from inadequate system validations, manual data entry errors, and inadequate inter-system linkages for flow of data.

All Information

• Manage data

Establish data governance framework. To do that, as the author argues,—

1. understand the context for the data and its undented usage
2. decide how the data can be structured to optimally support their best use
3. mandate how a company will manage its data
4. determine who and how is involved in the data management, and
5. identify the processes to ensure clarity, consistency, and coordination.

• Remember to comply with confidentiality, bank secrecy, personal data, and data protection regulations

Particular Information

• Manage legal data
• Create legal data standards

For example, check the ISDA taxonomy and clause library project.

• Manage legal knowledge

The author suggests to maintain —

1. standard templates
2. transaction precedents
3. clause libraries, and
4. other ‘know-how’ documents (internal emails, law firm bulletins, etc.).

• Employ and maintain taxonomies for legal data

As the author states, taxonomies should be understandable, follow a logical hierarchy, and conform to other published taxonomy standards when possible.

• Store and manage the lifecycle of legal opinions

The author points out a close interaction between client, product, and agreement taxonomies that might be used within the legal opinions.

Also there should be the data lineage between legal opinions, master agreements, transactions governed by each master agreement, and the relevant netting determination.

Hedge Not Destruct

(Derivatives are not only weapons of massive destruction, by the way. One can use derivatives in the legitimate ways— like hedging, speculation, cash flow management, or indirect investment in an underlying asset.)

• Manage ISDA derivatives documentation data

To do that, as the author argues, —

1. manage cases where standard provisions are amendment in ways that would not have been expected by the pro-forma
2. record correctly so as to be able to subsequently track the agreed position
3. link trades to master agreements that actually govern them
4. eliminate disconnection between descriptions of transactions in trading systems and legal agreement systems, and
5. abstain from employing multiple systems for storing master agreement terms for different purposes.

Pure Gold

• Manage close-out netting data

One need to —

1. develop an infrastructure in terms of legal opinion storage and linkage with legal agreements dependent on the close-out legal opinion in order to net, and
2. as close-out netting is a dynamic concept, be prepared to periodically refresh close-out netting opinions.

• Beware of tainting the netting setting

As the author points out, this is the case when the validity of close-out netting provisions in the master agreement relating to all transactions may be called into question because of that a set of transactions with a branch of any party in one jurisdiction cannot be included in close-out netting calculations.

Secure Collateral

• Manage collateral data

Collateral data plays a big role in the recovery and resolution plans, liquidity management and reporting.

However, as the author fairly states, multiple silos of collateral data exist and result in duplicative infrastructure, inconsistent data maintenance, and use of data for improper purposes.

• Determine a person responsible for managing collateral data

It remains disputable who is best placed to be a source of collateral data (legal teams, or collateral management teams, or chief data officers, or else).

Interestingly, there are collaborative platforms aimed at mitigating that issue, like ISDA Create and MarginXchange.

Liquidity Wanted

• Manage legal data to comply with liquidity requirements

Such requirements particularly concern liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) — or the similar indicators and rules in the respective jurisdictions.

To achieve the management goals, as the author states, —

1. understand and factor the liquidity and other related implications of contractual terms
2. produce contractual cash flows over the entire lifetime of the transactions according to various dimensions (legal entity, currency, line of business, etc.)
3. align contractual cash flows to books and records, and
4. integrate legal agreement, trade, risk, finance, exposure measurement and collateral management systems. (In this context, among legal agreement data are close-out netting determinations, rating downgrade termination events, rehypothecation rights, contractual contingent liability clauses, collateral eligibility details, etc.)

One More Try

• Manage legal data in course of recovery and resolve procedures

First and foremost, prepare and implement the data-gathering plan.

Also be prepared—

1. to have large amounts of legal data ready for use within tight deadlines. (Such data includes applicable insolvency and regulatory regimes, qualified financial contracts, pre-emptive actions to preserve critical functions, cross-default clauses, inter-company guarantees, service agreements, cross-collateral arrangements, cross-affiliate netting agreements, etc.)
2. to transmit legal data to state authorities at request. (This challenges the need to comply with cross-border privacy, banking secrecy, and data protection laws.)

Mistake-Proof

• Credit agencies can judge poorly

The rating agency may incorrectly rate products and entities — due to inexperience, errors of judgement, or information asymmetry.

As credit rating agencies use the ‘issuer pays’ model, there are incentives to assign higher credit ratings to attract fees.

The rating becomes sensitive in view of ratings-event-driven clauses which may potentially increase the overall probability of the party’s default.

Innovations

• Implement data-oriented contracts

Draw structured legal data from the very beginning.

The author claims data-oriented contracts can —

1. facilitate identification of clauses that are under risk of a new interpretation through a search of such terms
2. enable to detect conflicts between opposing contractual obligations within a contract portfolio and make business decisions as to how to deal with them
3. ensure the risks are monitored better, and
4. combine the contractual data with market data in order to put business perspective to the commercial terms and their business impact.

• Turn unstructured legal data into structured legal data

Take XML or FpML® (Financial products Markup Language) formats as an example.

• To be bound by the structured data representation, the parties should mutually agree on its definitions
• Employ enterprise contract management (ECM)

Test creation of contracts based on a user’s responses to questions/input from other systems, collaboration tools, integration with trading/sales and client data systems, and other ECM solutions.

• Employ contract negotiation platform

A user interface where the contracting parties enter commercial and operational details into labelled entry boxes can, as the author states, —

1. reduce uncertainty in communication and negotiation of the commercial and operational terms
2. ensure consistent formatting and style of structured data, and
3. generate a full‐blown natural language representation of the agreed terms based on a series of predefined rules.

The platform can be equipped with e-signature software.

Among the best candidates for the platform are standard form contracts.

Contract negotiation platform requires agreement between the contracting parties to the various constraints imposed on the drafting. This can be done, among others, through an industry body or trade association.

• Natural language processing (NLP), artificial intelligence (AI) and machine learning (ML) tools and e-discovery can help to automate legal data extraction
• Take steps — in terms of document preparation and storage — to assist any digitisation process

Newborns

• Smart contracts and distributed ledger technologies (DLT) are 2 complimentary — albeit distinct — technologies

Note that blockchain is not the only DLT. Consider, e.g., Hashgraph.

• Smart contract is a coded instruction which executes on the occurrence of an event
• Distinguish smart contracts from Ricardian contracts

The author notes that smart contracts are the execution of the agreement, while Ricardian contracts are the ‘best effort’ to record the agreement.

• Smart contract technology has both advantages and drawbacks

Advantages include accuracy and certainty for transaction records, lower execution risk, reducing the need for intermediaries, as well as speed and real-time updates.

Drawbacks include legal and operational risks.

• A smart contract operates through Boolean algebra — therefore, it is likely to be (too) difficult and time consuming to draft smart contracts to deal with ambiguous terms

The author suggests that one can break legal contracts into —

1. operational clauses — they closely align with Boolean algebra as they require an action upon the occurrence of a specified event or at a specified time, and
2. non-operational clauses — they do not align easily with Boolean algebra as they often refer back to wider legal obligations

• As of now, the legal status of smart contracts technology is yet to be tested by the courts

However, the basic principles of contract law apply to decide whether a smart contract is capable of being legally binding.

• Smart contracts would execute regardless and could not be legally reversed — unless reversal scenarios were coded for
• The legal layer and technical code layer should align

If not, issues of liability/validity will emerge.

• New technologies are subject to increasing cybersecurity concerns

Check the DAO (Decentralised Autonomous Organisation) hack which occured in June 2016.

• Smart contract and DLT must learn to walk before they can run

This is my favorite observation!

Traditions & Laws

• There are 2 major legal traditions — common or civil law

Common law subordinates statutes to judicial decisions, and civil law does vice versa.

Common law operates as an adversarial system, and civil law operates as an inquisitional one. (In an adversarial system, the argumentation between two opposing sides will lead to the best determination of the truth, and judges propose new rules to cover facts that have not yet been presented to them. In an inquisitional system, the truth is best discovered through an impartial inquiry, and judges have less scope to shape the law than the legislators who draft it.)

• Common law dominates the financial sector

The author argues that common law offers predictability, transparency, and flexibility.

Judges can quickly adapt the common law and without the need for legislation to be amended.

Also judges can determine whether parties acted in accordance with the spirit of the contract and not just the black letter of the law.

In the meantime, civil law offers weaker protection to investors — it facilitates structuring transactions that conform to the letter of the law, but are unfair. (If a party has acted in bad faith, but not illegally, a civil law court may not be able to remedy the wrong since statute will not specifically cover it.)

• Equity is a jewel

Equity is only applied at the discretion of the court and is used on the basis of equity maxims (‘equity follows the law,’ ‘equity looks at the substance, not the form,’ ‘he who seeks equity must do equity,’ ‘delay defeats equity,’ and others).

Among advantages of the equity are equitable remedies, such as an injunction, specific performance, rescission, and rectification.

• When choosing a governing law, consider reputation, popularity, and accessibility of competent and experienced lawyers

The author points out that —

1. the law should provide fairness and certainty, be in use in international commercial and financial contracts, and be properly advised on affordable terms at any time — from contract negotiation to dispute resolution, and
2. laws differ in their attitude to debt, credit, and insolvency. (For example, the English and US law are generally creditor‐friendly in respect of insolvency issues.)

• English law and New York law dominate international finance

As the author observes, both form a sort of an international standard.

Disclaimer: This is my personal blog. This is neither a legal opinion nor a piece of legal advice. The opinions I express in this blog are mine, and do not reflect opinions of any third party, including employers. My blog is not an investment advice. I do not intend to malign or discriminate anyone. I reserve the right to rethink and amend the blog at any time, for any or no reason, without notice.