The future of financial contract documentation

The legal industry is ripe for an injection of modern technology and that has not gone unnoticed by myriad start-ups all vying to bring the revolution.

Creating better ways of doing things is often the easy part; the culture shift required for adoption is much harder, particularly when dealing with a profession steeped in tradition.

The question becomes not whether the revolution will happen, but how and when it will happen, and what are the interim steps needed to ease the culture change and adoption shift required.

Lets first examine the current state of legal process and technology in banking to understand the ‘gap’.

Current State

People

Currently banks operate their own legal departments, augmented with outside council for specialism, and use process outsourcing and alternative legal providers to deal with peaks created by regulatory burden. Within financial institutions, legal departments are a ‘cost centre’ and cost centres are often under funded and over worked leading to fire-fighting and tactical decisions rather than strategic thinking and long term efficiency.

Process

Much of the work in contract generation and interpretation is reactive and outside of the legal departments control. The catalysts for work are typically new business (such as on boarding new clients) driven by sales and trading, tweaks to existing contracts (often driven by market events – think Brexit, or ratings downgrades), or regulation (loads of examples here – think Mifid II, Uncleared Margin Reform etc.).

Technology

At its most basic, banking legal department technology includes somewhere to store existing contracts (document management system, file share), somewhere to negotiate contracts (phone, email), and some way to create contracts (Microsoft Word review and red-line tools).

Larger organisations will often utilise contract lifecycle management software to help manage the workflow that wraps this, with additional tooling to try and manage risks and obligations under contracts.

The problem

Superficially the technology components should be sufficient, however the reality is problematic:

• Hard to find data
  • Contracts are poorly indexed in the storage – typically executed contracts are stored as image based scans, with any metadata (e.g. counterparties, dates, contract type) manually set, or not set at all
  • Agreement dates are poorly captured – the only way to know the effective date of a document may be to open it and read it.
  • Agreement families (originals and associated amendments) are all lumped into a single folder, with inconsistent file naming conventions, and sporadic metadata
• Lack of standardisation in creation
  • Contract authoring relies on generation of documents – at best a set of templates is used which hopefully incorporates the latest thinking, but in many cases existing contracts are ‘cleaned out’ and reused, potentially lacking in the latest terms, propagating past mistakes, and prone to ‘cut and paste’ errors
• Hard to manage risks and obligations
  • Negotiated contracts are written by different lawyers, often in ways that make interpreting and extracting the operational data for downstream use very complex
  • Data is re-typed, often using people lacking the necessary appreciation of the meaning or impact of the data and often into systems that do not have suitable ways to store the data, leading to an additional level of interpretation between operational data and executed contract

Current state of Available legal technology

The gap between the available technology and adoption is where much of the problem lies.

A number of solutions already exist to address many of the problems above.

Document management systems allow contracts to be indexed by multiple identifiers and grouped into families, ordered chronologically.   E-discovery and search tools incorporating artificial intelligence allow very rapid initial triage across a wide population of contracts.

Tools exist to automate contract creation with everything from questionnaire style workflows and templates that enforce business rules, through to those that provide for full negotiation of industry standard contracts in a cloud hosted environment, tracking approvals and sign offs and enforcing business logic. Risk and operational data, at least for the more standard provisions, can often be captured at point of authoring, reducing the need for extracting data later.

Contract management tools exist that include automated data extraction techniques, using machine learning, algorithmic and natural language processing to improve efficiency and accuracy of data collection for operational, regulatory and risk management purposes, with appropriate data structures to house all the important data elements. Modern contract extraction tools incorporate the relevant standards based application programming interfaces to facilitate efficient data exchange with key banking software such as risk, collateral and trade management platforms.

Current adoption

Adoption of the technologies listed above is sporadic at best. A recent example of this can be seen from the Uncleared Margin Reform regulation affecting derivatives contracts.

The upcoming deadlines were well publicised. The product vendor’s offerings were well thought through and marketed.   What happened in practice was a reflection of the fire-fighting reality of understaffed legal departments and a lack of cultural adoption:

• Rather than use automated document authoring or hosted negotiation platforms, most lawyers reached for Microsoft Word
• Many negotiations were outsourced and while the outsourced companies fronted the work, in a lot of cases the pool of qualified negotiators was limited and often sourced from the contract market. This lead to inconsistencies in negotiation and stored up operational challenges
• Rather than take the opportunity to clean up poorly organised contracts, most added to the mess by layering existing, suspect data, with newly created contract data. Rather than keep a record of where the data came from in the executed contracts, they simply loaded an extract, often via Microsoft Excel and comma separated formats, into their existing systems, losing granularity. They will later revisit these contracts to capture the missing data in the future.

Optimal Future state

The good news is that most organisations, burdened with regulation and cost cutting and emerging with the scars from such projects are realising that in the longer term it will be quicker, cheaper and less painful to just do things properly the first time.

To progress efficiently there needs to be recognition that technology alone cannot solve the problems. The people and process elements need addressing too. Given the cross-departmental nature of the stakeholders in legal contracts and their data, it is key to establish ownership for end-to-end process flows. Without this it is too easy to think that someone else is addressing the problems, or end up with operational silos, which create inefficiencies at the ownership boundaries.

Logical Construct’s vision (click to see graphical guide) of how those seeking to move from current state to future state should make this shift – its all available now! In seeking new technologies, beware the glitzy, canned demos – if it looks too much like magic, it probably won’t work that way in practice. Ensure you consider the true complexities of your need when selecting solutions, and remember to address the people and process aspects too…