ISDA Says Clear Rules Are Needed to Govern Ownership of Digital Assets when Intermediaries Go Bankrupt

ISDA argued the need for clarity in rules that govern the ownership of customer digital assets in the event of an intermediary’s insolvency.

In a White Paper titled "Navigating Bankruptcy in Digital Asset Markets: Digital Asset Intermediaries and Customer Asset Protection," ISDA asserted that the same "traditional and fundamental" protections that have been established through clear legal terms and the segregation of assets can also be applied to digital assets. ISDA said that by providing regulatory clarity based on "unambiguous and enforceable property rights," U.S. and UK lawmakers can ensure digital asset customers will have the same protections they could expect from traditional assets or financial products.

ISDA explained that both U.S. and English law (i) have existing private law concepts that, in the event of insolvency, can be applied to digital assets to protect customer assets, (ii) require regulated intermediaries to comply with custodial arrangements and protections of customers’ digital assets, including for segregation and bankruptcy and (iii) can apply existing insolvency regimes to digital asset intermediaries.

ISDA acknowledged that distributed ledger technology may present certain legal questions in comparison to traditional financial assets. ISDA said that a customer seeking exposure to a digital asset through an intermediary may face "legal uncertainties," concerning the asset itself, such as (i) which jurisdiction the digital asset falls under and (ii) how a proprietary claim to an asset can be enforced in such jurisdiction.

Before entering into custody arrangements, ISDA recommended that customers and intermediaries consider:

• the level of customer asset protection necessary based on their intended trading or investment activity;
• which jurisdiction would govern the insolvency of the intermediary and the rights a customer has under the jurisdiction’s law with regard to digital and customer assets;
• the rights granted to the customer and intermediary, respectively, under their prospective contractual agreement;
• any contractual or regulatory obligations an intermediary must adhere to, if any, to segregate customer assets from its own; and
• the intermediary’s operational approach to record and segregate customer assets, in addition to security mechanisms to protect such operations.

ISDA made clear that "omnibus segregation" of client assets should be the standard for client asset protection, but that the customer should always be able negotiate higher or lower levels of protection.