Recommendation 13: Master Agreements

Dealers and end-users are encouraged to use one master agreement as widely as possible with each counterparty to document existing and future derivatives transactions, including foreign exchange forwards and options. Master agreements should provide for payments netting and close-out netting, using a full two-way payments approach.

The greatest legal certainty that credit exposure will be determined on a net basis exists when transactions between two parties are documented under a single master agreement. The use of multiple master agreements between two parties may introduce in some jurisdictions the risk of "cherry-picking" between or among master agreements (rather than between or among individual transactions) or that the right to set off amounts due under different master agreements will be subject to a stay or otherwise delayed. While legislative developments in the United States have helped to diminish some of the concerns associated with the use of multiple master agreements with certain counterparties, in general dealers will be well served by using a single master agreement with counterparties to document as many transactions as is prudent in light of any applicable legal or regulatory constraints.

Settlement of payments on a net basis (settlement or payment netting) is an important provision that should be included in the master agreement. Each time a dealer and its counterparty are required to make a payment to the other on the same day and in the same currency, whether under a single transaction or multiple transactions, settlement risk is present. The ability to net these payment obligations under a large number of transactions thus will minimize settlement risk by reducing the amount, and sometimes the number, of payments required to be made. The use by a dealer of a single master agreement with a counterparty for as many transactions as possible thus will reduce the settlement risk of payments made in the same currency, but will not eliminate cross currency settlement risk- the so-called Herstatt risk, named after the 1974 failure of Bankhaus Herstatt.

Generally, the relevant documentation provisions to reduce and control credit risk fall into three interrelated categories: up-front risk assessment; ongoing monitoring and risk reduction; and early termination to limit exposure. The standard documentation provisions cover common concerns and often are tailored further to address special needs.