For credit enhancement, a counterparty can also obtain letters of credit (from a bank acceptable to both parties) in an amount large enough to support the maximum potential exposure on the underlying swap. If the counterparty supported by the letter of credit fails to perform its obligations under the terms of the derivatives transaction(s), the other counterparty has the right to draw upon the letter of credit to remedy whatever shortfall exists.

Several dealers motivated by the participants´ requirements with respect to counterparty credit risk recently have developed special vehicles for OTC derivatives ("AAA subsidiaries") which are structured and operate in a manner that removes the direct credit risk of the parent and provides enhanced credit protection to counterparties. Several features are common in the AAA subsidiary structures which have been established to date:

• Capitalization
  The primary form of AAA subsidiary credit support is the use of a cushion of excess capital. Credit rating agencies tend to require that the capital of an AAA subsidiary be able to withstand the most extreme stress scenario involving severe market movements.

• Bankruptcy Remote
  Another important requirement is that the AAA subsidiary must be legally separate from its parent so that it will not be combined or consolidated with the parent in the case of the bankruptcy or insolvency of the latter.

• Operating Guidelines
  AAA subsidiaries manage credit risk by managing their portfolios in accordance with specific operating guidelines. The guidelines comprise a range of ratios, triggers, and limits to achieve diversification. They can include absolute dollar or percent of capital limitations on counterparties, including the parent. Other alternatives may limit total exposure to counterparties in certain rating categories at a fixed dollar amount or a percentage of capital. Industry or country limitations may also be used to diversify the portfolio.

• Matching and Affiliate Transactions
  This feature restricts the AAA subsidiary from taking any open or unmatched positions. They must be continuously hedged. This often is accomplished by requiring that the AAA subsidiary enter into a mirror transaction with its parent or an affiliate for every transaction it enters into with a third party. The AAA subsidiary´s exposure to the parent or affiliate may need to be fully collateralized. In some structures, the parent or affiliate also is obliged to collateralize any excess exposures of the AAA subsidiary. The AAA subsidiary also may assign to the parent or affiliate any transaction with a counterparty that has caused it to breach its operating guidelines (e.g., because of a downgrade, excess exposure of counterparty default).