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         V. Copunterparty Relationships


Framework for Voluntary Oversight

V. Copunterparty Relationships

I. Overview

This component of the framework consists of guidelines for firms engaged in business on a principal basis as professional intermediaries in the OTC derivatives market with respect to nonprofessional counterparty relationships. These guidelines are designed to foster integrity and responsible conduct in the market and are not intended to prescribe legal standards.

II. Guidelines for Professional Intermediaries

  1. Promotion of Public Confidence. A professional intermediary should conduct its OTC derivatives activities honestly, in good faith and in a manner consistent with the promotion of public confidence in the integrity of the market.

  2. Generic Risk Disclosure. A professional intermediary should consider providing new nonprofessional counterparties with disclosure statements generally identifying the principal risks associated with OTC derivatives transactions and clarifying the nature of the relationship between the professional intermediary and its counterparties.

  3. Nature of Relationship. OTC derivatives transactions are predominantly arm's-length transactions in which each counterparty has a responsibility to review and evaluate the terms and conditions, and the potential risks and benefits, of prospective transactions and to obtain such additional information or independent professional assistance as it may require in connection with a particular transaction.

    In cases where existing transaction documentation does not expressly address the nature of the relationship between the professional intermediary and its nonprofessional counterparty and the professional intermediary becomes aware that the nonprofessional counterparty believes incorrectly that the professional intermediary has assumed advisory or similar responsibilities toward the nonprofessional counterparty with respect to a prospective OTC derivative transaction, the professional intermediary should take steps to clarify the nature of the relationship.

    A professional intermediary should not make representations to a nonprofessional counterparty with a view to creating a misleading impression that the professional intermediary will assume advisory or similar responsibilities toward its counterparty in connection with an OTC derivative transaction.

    A professional intermediary should be aware of statutes and regulations which may apply in particular circumstances and create affirmative advisory or fiduciary duties or obligations.

  4. Marketing Materials. A professional intermediary should prepare marketing materials in good faith and not with a view to misleading the recipient with respect to the potential risks and benefits of a proposed OTC derivative transaction.

  5. Specific Transaction Proposals. In circumstances where a professional intermediary, at the express request of a nonprofessional counterparty, formulates a specific OTC derivative transaction proposal that is tailored to particular transactional objectives specified by the counterparty, the professional intermediary should formulate the transaction proposal in good faith based on the information and objectives specified by the counterparty and subject to t} terms of the parties' contractual arrangement.

  6. Special Situations. In circumstances where a nonprofessional counterparty has expressly requested assistance in evaluating an OTC derivative transaction in which the payment formula is particularly complex or which includes a significant leverage component, the professional intermediary should offer to provide additional information, such as scenario, sensitivity or other analyses, to the nonprofessional counterparty or should recommend that the counterparty obtain independent professional assistance.

  7. Scenario or Other Analyses. A professional intermediary that undertakes to provide scenario or sensitivity analyses or other calculations (such as maturity sensitivity tables) with respect to an OTC derivative transaction to a nonprofessional counterparty should make a good faith effort to perform those calculations accurately.

    If scenario or other analyses are prepared at a nonprofessional counterparty's request and the counterparty does not stipulate some or all of the assumptions to be used in making the calculations, the professional intermediary preparing the materials should effect the calculations on the basis of good faith assumptions and not with a view to presenting a misleading picture of the potential risks and benefits of the scenarios analyzed.

    A professional intermediary that provides written materials to a nonprofessional counterparty that contain scenario or sensitivity analyses or other calculations should consider including legends with those materials that identify various assumptions underlying the analyses presented, describe market factors that may affect the analysis, and/or inform the party receiving the materials that a variety of assumptions and market factors may affect the analysis.

  8. Terms of the Transaction: Meeting of the Minds. A professional intermediary should generally use written agreements, transaction confirmations, term sheets or other written materials to clarify the t, and conditions of OTC derivatives transactions and the respective obligations of the parties.

    Where the terms of an OTC derivative transaction are not reflected in a writing (such as in markets or circumstances where it is not customary or practicable to do so), a professional intermediary should exercise particular care to assure that it has reached a common understanding with its nonprofessional counterparty as to the material economic terms of the transaction.

  9. Valuations and Quotations. A professional intermediary should exercise good faith in the determination of valuations and quotations for OTC derivatives transactions and should not prepare or communicate valuations or quotations to a nonprofessional counterparty with a view to misleading the counterparty.

    If a professional intermediary believes that the nature of any quotation or valuation given by it to a nonprofessional counterparty is unclear to the counterparty, the professional intermediary should take steps to clarify the nature of the quotation or valuation (e.g., whether the valuation or quotation is an indicative price quotation, a firm price quotation or a mid-market valuation) and should consider indicating, where appropriate, that valuations may vary from firm or indicative price quotations as a result of various factors and may vary from valuations that would be given by another professional intermediary.

III. Internal Policies and Controls, Supervision and Other Measures

  1. Generally. The internal management controls adopted by a professional intermediary to reduce the risk of inadvertent loss should include internal policies and procedures designed to foster the promotion of strong counterparty relationships and to reduce the risk of misunderstandings and contractual disputes.

    At the same time, the character and level of risk that is desirable for a particular market participant is a business judgment that is appropriately made by the participant's governing body or management, in accordance with any applicable statutory or regulatory constraints, based on an evaluation of the totality of its particular circumstances and objectives.

  2. Legal Capacity, Authority and Creditworthiness. Before entering into any OTC derivative transaction, a professional intermediary should evaluate:

    1. its counterparty's legal capacity and authority to enter into OTC derivatives transactions; and

    2. the creditworthiness of its counterparty.

  3. Supervision and Controls. Management of a professional intermediary should have in place necessary mechanisms for supervising the activities of personnel engaged in OTC derivatives activities, including, in particular, mechanisms for internal review and approval of written materials relating to OTC derivatives transactions.

  4. Legal Documentation Review. A professional intermediary should review the form of written agreements and other documentation used in connection with OTC derivatives transactions on an ongoing basis in light of changes in market practices or law.

  5. Recordkeeping. A professional intermediary should review its record creation and maintenance procedures with a view to the retention of documentation with respect to OTC derivatives transactions that would be helpful in connection with the resolution of contractual disputes.

  6. Training. A professional intermediary should implement programs for the training of personnel involved in OTC derivatives transactions regarding the nature of the market and the responsibilities of market participants. In particular, personnel should be trained to identify circumstances involving counterparty relationships that may present special situations.

  7. Special Situations. A professional intermediary should implement policies and procedures to address special situations involving OTC derivatives transactions that may present a heightened risk of contract repudiation or raise other concerns Such policies and procedures should include policies calling for the consideration of such situations by additional qualified personnel.

IV Uniform Guidelines

Ideally, guidelines with respect to counterparty relationships should be adopted uniformly by all professional intermediaries in the OTC derivatives market. The adoption of uniform guidelines by all professional intermediaries would eliminate competitive inequalities and would facilitate consensus on a broader body of agreed practices in the OTC derivatives market.

The firms represented on the DPG expect to continue active participation in industry-wide efforts to establish more broadly applicable guidelines with respect to counterparty relationships in the OTC derivatives market.

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