Global over-the-counter derivatives activity is relatively new, and until now there has been no thorough study of its management. Dealers and end-users, while aware of the broader challenges, have focused their discussions on specific issues--and have addressed these with a variety of practices, some more effective than others.

This Study presents the first comprehensive effort to take stock of what the industry has learned, and to broaden awareness of the more successful management approaches. It provides practical guidance in the form of 20 recommendations addressed to dealers and end-users alike (some firms perform both functions). These recommendations can help them to manage derivatives activity, to respond to its growth and complexity, and to continue to benefit from its use.

The recommendations, which the Steering Committee has endorsed unanimously, were formulated by the Working Group--a diverse cross-section of end-users, dealers, academics, accountants, and lawyers involved in derivatives. Input also came from a detailed Survey of Industry Practice among 80 dealers and 72 end-users worldwide, involving both questionnaires and in-depth interviews.

Some of the recommendations reflect a strong consensus among participants, and are already in widespread use; others represent the Working Group's choice among alternative practices. Still others point to emerging practices currently followed by a handful of participants.

These 20 recommendations are not necessarily the only means to good management. What they do offer is a benchmark against which participants can measure their own practices.

To summarize, the recommendations suggest that each dealer and end-user of derivatives should:

• Determine at the highest level of policy and decision making the scope of its involvement in derivatives activities and policies to be applied.
• Value derivatives positions at market, at least for risk management purposes.
• Quantify its market risk under adverse market conditions against limits, perform stress simulations, and forecast cash investing and funding needs.
• Assess the credit risk arising from derivatives activities based on frequent measures of current and potential exposure against credit limits.
• Reduce credit risk by broadening the use of multi-product master agreements with close-out netting provisions, and by working with other participants to ensure legal enforceability of derivatives transactions within and across jurisdictions.
• Establish market and credit risk management functions with clear authority independent of the dealing function.
• Authorize only professionals with the requisite skills and experience to transact and manage the risks, as well as to process, report, control, and audit derivatives activities.
• Establish management information systems sophisticated enough to measure, manage, and report the risks of derivatives activities in a timely and precise manner.
• Voluntarily adopt accounting and disclosure practices for international harmonization and greater transparency, pending the arrival of international standards.

In addition, there are four recommendations for legislators, regulators, and supervisors. To help strengthen the financial infrastructure for derivatives activities, officials are called upon to:

• Recognize close-out netting arrangements and amend the Basle Accord to reflect their benefits in bank capital regulations.
• Work with market participants to remove legal and regulatory uncertainties regarding derivatives.
• Amend tax regulations that disadvantage the economic use of derivatives.
• Provide comprehensive and consistent guidance on accounting and reporting of derivatives and other financial instruments.

The recommendations are generally grouped below according to specific areas of study. Six subcommittees of the Working Group addressed these areas in detail. Their Working Papers, published separately as Appendix I, form the basis for these recommendations and provide essential background information.

Recommendations for Dealers and End-Users

These recommendations are addressed to participants in derivatives activity, both dealers and end-users. The terms "dealer" and "end-user" do not refer to particular types of institution, but rather to the nature of their derivatives activity. A bank, for instance, may participate both as a dealer and as an end-user. Likewise, some corporate end-users of derivatives may also be involved as dealers. (For information about who uses derivatives and why, see Section II of the Overview of Derivatives Activity)

General Policies - 1
Recommendations 1 - 12

General Policies - 2
Recommendations 13 - 24