Law firms won't escape digital disruption brought by blockchain

Blockchain technology could lead to faster processing of derivatives trades, with automatic verification and implementation of digital contracts. But this would also require law firms in this area to change the way they work. One approach could be to waive record-keeping requirements in the form of paper documents, such as contracts, and move to completely digital record keeping. The work towards achieving this is already taking place in some areas. For example, in April, Barclays plc announced successful tests for derivatives trades using smart contracts and blockchain-like technology.

As blockchain use in derivatives develops, handling the legal side of futures and options trading will have to adapt as well.

The promise of blockchain is that distributed ledger technology could lead to a world with faster processing of derivatives trades, spurred by automatic verification and implementation of digital contracts. But for law firms that deal with derivatives trading, electronic contracts and verification also will mean a change in how they do business.

“The legal impacts are certainly significant from a number of aspects,” said Terry Roche, principal and head of fintech research, TABB Group, New York. “Blockchain itself isn't really introducing any new technologies. Distributed ledger technology, cryptology, cryptanalysis have all been around for some time. What's new is that it's a different construct. It's the architectural approach that's different. Blockchain is distributed and open, not vertical like other systems.”

One legal question involves use of smart contracts, which are computer protocols that facilitate, verify or enforce the terms of a contract.

“The concept of smart contracts has been with us forever in computing, but it's been based on vertical systems,” Mr. Roche said. “With a change in that architecture, it could impact fund transfers, settlements, ownership of security contracts. There are all sorts of things out there that are legal agreements, all bespoke or for specific customers. What about those legal documents?”

That's the issue law firms are facing. As an industry, blockchain could mean a change in what those firms provide to their financial services clients, affecting, say, those that generate paper contracts to comply with myriad laws and regulations to others that primarily provide advice, said Yvette Valdez, New York-based counsel, derivatives practice group at the law firm of Latham & Watkins LLP.

“At some level, folks lose sight that until the leveraged finance industry grew up and made us documentation machines, we really just served as advisers,” Ms. Valdez said. “I think that we'll probably be going back to our original role as advisers. Blockchain will have the ability to innovate. That means the role of the lawyer will have to change, but with that change, we'll need to give regulators some time to catch up.”

Regulators already are starting that catch-up effort, but basically by following as observers as blockchain developers test applications for derivatives use. Some testing has proven successful; Barclays PLC in April said it had successfully tested a way to trade derivatives using smart contracts and blockchain-like technology being developed by a consortium of the world's leading banks led by financial services technology developer R3CEV.

Regulators like the Commodity Futures Trading Commission and its counterparts in the U.K., Europe and Asia have taken a “benign or do-no-harm” approach to block-chain regulations, including possibly waiving record-keeping obligations that require that contracts be kept in “native” form - usually on paper documents, said Eamonn Maguire, managing director, financial services, at KPMG, New York.

“That would be quite meaningful for the emergence of blockchain as the contracts and record keeping could all be digital, not physical,” said Mr. Maguire.

Officials at the CFTC did not respond to requests for comment.