DZ BANK and BayernLB have for the first time successfully traded an over-the-counter (OTC) interest rate derivative in the form of a digital smart derivative contract (SDC), with the resulting payments settled daily via Deutsche Börse.
They then processed the entire life cycle of this OTC derivative over several days in a fully automated and legally binding manner. The institutions have thus proved that such a transaction can be implemented completely digitally.
The three project partners implemented the digital OTC derivative using distributed ledger technology (DLT) and cloud technology. A smart derivative contract independently digitised the contract content and processed its terms. DZ BANK and BayernLB acted as trading partners. Eurex Clearing, the central counterparty (CCP) of Deutsche Börse, acted as a neutral account manager for exposures from this non-cleared OTC transaction.
Decisive advantages of smart derivative contracts are that the market value is calculated according to a contractually agreed uniform valuation model and outstanding receivables and liabilities are settled daily by automated booking (settled-to-market). Daily pre-financing ensures efficient payment processing. In addition, smart derivative contracts cushion default risks: automatic contract termination kicks in if contractual partners cannot meet the agreed terms and conditions. Distributed ledger technology serves as a digital accounting system for the recording and verification of transaction data, as well as for the automated settlement of exposures.
Smart derivative contracts thus not only simplify and accelerate the complex settlement processes of OTC derivatives. They also create an economic advantage for the participants in a transaction, because they reduce so-called counterparty risks – i.e. the default risk of a transaction partner – as well as procedural uncertainties.
The OTC derivative was implemented in cooperation with the Ludwig Maximilian University of Munich and with legal support from the law firm Jones Day. In the next step, further transactions with partners, e.g. from the asset management environment, are to follow.
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