Dealers may also consider the potential for correlation between market levels and the credit quality of their counterparties. If an end-user is using derivatives to hedge a business exposure, the dealers´ exposure to an end-user will occur when the end-user´s business operating results improve. In other cases, however, the opposite may be true: an extreme example would be the purchase of an over-the-counter put option on the common stock of the seller of the option. The exposure to the seller will be greatest when the credit quality of the seller is at its worst. Credit levels should be established which generally reflect the maximum potential exposure to a counterparty that is authorized by management. Dealers should set documentation and credit support strategies for different levels of counterparty exposures and maturities of transactions.

Almost 90% of end-users rely on credit ratings as a primary factor to approve counterparties. Of those that rely on credit ratings, 60% require uniform minimum credit ratings for all counterparties; a substantial number (approximately 30%) of respondents also impose minimum ratings that vary according to the types of transactions, their maturities, and the country in which the counterparty is domiciled. As a general rule, the counterparties are approved by either the treasurer or the chief financial officer of private sector corporations; in public sector entities and financial institutions, the counterparty approval also is often provided by the board of directors or a risk committee.

As discussed above, the potential exposure of a specific transaction depends on the transaction and the underlying instrument (e.g., interest rates, currencies, equities, or commodities). Before executing a new transaction with a counterparty, it is necessary to quantify the incremental risk that the transaction adds to the portfolio of transactions with that counterparty. There may be a natural offset to a proposed transaction within the existing portfolio of transactions, or a natural offset may be created.

Participants should also review exit strategies and liquidity implications prior to executing a transaction. Exit strategies that can be used to manage counterparty credit exposure include the outright termination of a transaction, the assignment of the transaction to another counterparty, and entering into an offsetting transaction with the counterparty to lock in the current credit exposure. Each of these exit strategies has different liquidity implications. For example, it may be difficult to assign or terminate a transaction with a troubled counterparty if the rest of the market is also trying to reduce their exposure to that counterparty. Liquidity can also be a factor in turbulent or thin markets. Finally, unusually complex transaction structures will have a limited number of potential assignees.

Parties should, whenever possible, execute a master agreement prior to entering into a transaction. This practice is designed to avoid potentially costly mistakes by ensuring that both parties fully understand the terms of the transaction prior to its execution. If time does not permit, parties should at least agree on all essential elements of the agreement first, particularly credit and tax matters. When transactions are executed, a dealer confirmation specifying the essential terms of the transaction should be sent out to the counterparty as soon as possible after the transaction and should be promptly signed and returned by the counterparty. When transactions are executed without a master agreement in place, strenuous efforts should be made to negotiate and execute the master agreement as soon as possible. In this regard, management should ensure that the backlog of deals lacking complete documentation is monitored. A report on aging, showing how long each transaction has been in place without a master agreement, should be prepared regularly and reviewed by management.