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Trading and Capital-Markets Activities Manual

Trading Activities: Legal Risk
Source: Federal Reserve System 
(The complete Activities Manual (pdf format) can be downloaded from the Federal Reserve's web site)

An institution's trading activities can lead to significant legal risks. Failure to correctly document oral transactions can result in legal disputes with counterparties over the terms of the agreement. Even if adequately documented, agreements may prove to be unenforceable if the counterparty does not have the authority to enter into the transaction or the terms of the agreement are not in accordance with applicable law. 

While the legal risks associated with trading activities vary depending on the type of activity, over-the-counter (OTC) derivative transactions, in particular, give rise to the risk that a contract could be unenforceable if challenged. Master agreements with netting provisions, whether used in connection with OTC derivatives or other transactions, also give rise to a risk that the netting provisions of the agreements may be unenforceable. The unenforceability of a netting agreement may expose an institution to significant losses if it relied on the netting agreement to manage its credit risk or for capital purposes. 

As part of sound risk management, institutions should take steps to guard themselves against legal risk. Active involvement of the institution's legal counsel is an important element in ensuring that the institution has adequately considered and addressed legal risk. An institution's policies and procedures should include appropriate review by in-house or outside counsel as an integral part of the institution's trading activities, including new-product development, credit approval, and documentation of transactions. While some issues, such as the legality of a type of transaction, may be addressed on a jurisdiction-wide basis, other issues, such as enforceability of multi-branch netting agreements covering several jurisdictions, may require review of individual contracts. 

This section discusses some of the primary areas of concern with respect to legal risk. These issues generally are of greatest concern in connection with OTC derivatives contracts, but are relevant to other trading activities, as well. 

DOCUMENTATION 

If the terms of a transaction are not adequately documented, there is a risk that the transaction will prove unenforceable. Many trading activities, such as securities trading, commonly take place without a signed agreement, as each individual transaction generally settles within a very short time after the trade. The trade confirmations generally provide sufficient documentation for these transactions, which settle in accordance with market conventions. Other trading activities involving longer-term, more complex transactions may necessitate more comprehensive and detailed documentation. Such documentation ensures that the institution and its counterparty agree on the terms applicable to the transaction and satisfies other legal requirements, such as the ''statutes of frauds'' that may apply in many jurisdictions. Statutes of frauds generally require signed, written agreements for certain classes of contracts, such as agreements with a duration of more than one year (including both longer-term transactions such as swaps and master or netting agreements for transactions of any duration). Some states, such as New York, have provided limited exceptions from their statutes of frauds for certain financial contracts when other supporting evidence, such as confirmations or tape recordings, is available. 

In the OTC derivatives markets, the prevailing practice has been for institutions to enter into master agreements with each counterparty. Master agreements are also becoming common for other types of transactions, such as repurchase agreements. Each master agreement identifies the type of products and specific legal entities or branches of the institution and counterparty that it will cover. Entering into a master agreement may help to clarify that each subsequent transaction with the counterparty will be made subject to uniform terms and conditions. In addition, a master agreement that includes netting provisions may reduce the institution's overall credit exposure to the counterparty. 

An institution should specify its documentation requirements for transactions and procedures for ensuring the consistency of documentation with orally agreed-on terms. Transactions entered into orally with documents to follow should be confirmed as soon as possible. Documentation policies should address the terms to be covered by confirmations for specific types of transactions and transactions that are covered by a master agreement; policies should specify when additional documentation beyond the confirmation is necessary. When master agreements are used, policies should cover the permissible types of master agreements. Appropriate controls should be in place to ensure that confirmations and agreements used satisfy the institution's policies. Additional issues related to the enforceability of the netting provisions of master agreements are discussed below (see ''Enforceability Issues''). 

TRIGGER EVENTS 

Special attention should be given to the definition of trigger events that provide for payment from one counterparty to another or permit a counterparty to close out a transaction or series of transactions. While in the ordinary course of events, these contractual disputes can be resolved by parties who wish to continue to enter into transactions with one another, they can become intractable in the event of serious market disruptions. Indeed, the 1998 Russian market crisis raised calls for the establishment of an international dispute resolution tribunal to handle the large volume of disputed transactions when the Russian government announced its debt moratorium and restrucEagle Tradersg. 

Trigger events need to be clearly and precisely defined. In the Russian crisis, the trigger events in some master agreements did not include a rescheduling of or moratorium on the payment of sovereign debt. Even where sovereign debt is covered by the master agreement, it may be appropriate to specify that not only debt directly issued by the sovereign, but also debt issued through governmental departments and agencies or through other capital-raising vehicles, falls within the scope of the trigger event. Moreover, when a trigger event has occurred, but the contract expires before the expiration of a cure period or before the completion of a debt restrucEagle Tradersg, the non-defaulting party can lose the protection of the contract absent clear provisions to the contrary. 

The occurrence of trigger events also may give rise to disputes regarding the appropriate settlement rate at which to close out contracts. It may be difficult to argue in favor of substitute settlement rates that were not referenced as a pricing source in the original documentation. However, original pricing sources may not be available or may be artificially maintained at non-market rates by a government seeking to preserve its currency. 

Contracts also should be clear as to whether cross-default provisions allow or require the close-out of other contracts between the parties. Finally, close-out provisions should be reviewed to determine what conditions need to be met before the contract can be finally closed out. Formalities in some contracts may delay the close-out period significantly, further injuring a non-defaulting counterparty. 

LEGAL CAPACITY 

If the counterparty does not have the legal authority to enter into a transaction, the institution runs the risk that a legal challenge could result in a court finding the contract to be ultra vires and therefore unenforceable. Significant losses in OTC derivatives markets resulted from a finding that swap agreements with municipal authorities in the United Kingdom were ultra vires. Issues concerning the authority of municipal and other government units to enter into derivatives contracts have been raised in some U.S. jurisdictions, as well. Other types of entities, such as pension plans and insurance companies, may need specific regulatory approval to engage in derivatives transactions. 

A contract may be unenforceable in some circumstances if the person entering into the contract on behalf of the counterparty is not authorized to do so. Many entities, including corporations, have placed more extensive restrictions on the authority of the corporation or its employees to enter into certain types of derivatives and securities transactions. 

To address issues related to counterparty authority, an institution's procedures should provide for an analysis, under the law of the counterparty's jurisdiction, of the counterparty's power to enter into and the authority of a trading representative of the counterparty to bind the counterparty to particular transactions. It also is common to look at authorizations of boards of directors or trustees to enter into specific types of transactions. Depending on the procedures of the particular institution, issues relating to counterparty capacity may be addressed in the context of the initial credit-approval process or through a more general review of classes of counterparties. 

LEGALITY 

Concerns have been raised in a number of jurisdictions, including in the United States, as to whether OTC derivative transactions would be considered illegal under various statutes prohibiting gambling contracts, bucket shops, or off-exchange futures trading. In the United States, the threatened application of the offexchange-trading prohibition of the Commodity Exchange Act (CEA) to OTC derivative transactions presented a significant legal risk. However, the Commodity Futures Trading Commission (CFTC) has exempted a broad range of OTC derivatives from the CEA, eliminating the risk that instruments meeting certain conditions would be found to be illegal off-exchange futures. The exemption nevertheless limits the use of multilateral netting and similar arrangements for reducing credit and settlement risk, and reserves the CFTC's enforcement authority with respect to fraud and market manipulation.1 

The CFTC's exemption provides significant comfort with respect to the legality of most OTC derivative instruments within the United States. The risk that a transaction will be unenforceable because it is illegal may be higher in other jurisdictions, however. Jurisdictions outside the United States also may have licensing or other requirements that must be met before certain OTC derivatives or other trading activities can be legally conducted. 

To address the risks that a transaction may be unenforceable because of illegality, an institution should establish and follow procedures to ensure adequate review of new products. Products that are new to the institution and existing products being offered by the institution in a new jurisdiction should be covered. Legal review of products or transactions may take place as part of the new-product review or credit-approval process. 

NETTING 

To reduce settlement, credit, and liquidity risks, institutions increasingly use netting agreements or master agreements that include netting provisions. ''Netting'' is the process of combining the payment or contractual obligations of two or more parties into a single net payment or obligation. Institutions may have bilateral netting agreements covering the daily settlement of payments such as those related to check-clearing or foreign-exchange transactions. Bilateral master agreements with netting provisions may cover OTC derivatives or other types of transactions, such as repurchase agreements. 

1. See 17 CFR 35. Instruments covered by the CFTC's exemption also are excluded from the coverage of state bucket shop and gambling laws. 

Master Agreements 

Master agreements generally provide for routine transaction and payment netting and for closeout netting in the event of a default. Under the transaction and payment netting provisions of such an agreement, all payments for the same date in the same currency for all covered transactions are netted, resulting in one payment in each currency for any date on which payments are made under the agreement. Close-out netting provisions, on the other hand, generally are triggered by certain default events, such as a failure to make payments or insolvency. Such events may give the non-defaulting party the right to require early termination and close-out of the agreement. Under close-out netting, the positive and negative current replacement values for each transaction under the agreement are netted with respect to the non-defaulting counterparty to obtain a single sum, either positive or negative. If the sum of the netting is positive, (that is, the transactions under the agreement, taken as a whole, have a positive value to the non-defaulting counterparty), then the defaulting counterparty owes that sum to the non-defaulting counterparty. 

The results may differ if the net is negative, that is, the contracts have a positive value to the defaulting counterparty. Some master agreements include so-called ''walk-away'' clauses, under which a non-defaulting counterparty is not required to pay the defaulting counterparty for the positive value of the netting to the defaulting counterparty. The current trend, however, has been to require payments of any positive net value to either party, regardless of whether the party defaulted. Revisions to the Basle Capital Accord have reinforced this trend by not recognizing netting agreements that include a walkaway clause, as discussed more fully below. 

Enforceability Issues 

The effectiveness of netting in reducing risk depends on both the adequacy and enforceability of the legal arrangements in place. A major source of concern for market participants has been the enforceability in bankruptcy of the close-out netting provisions of master agreements covering multiple derivative transactions. When a bank has undertaken a number of contracts with a particular counterparty subject to a master agreement, the bank runs the risk that, in the event of the counterparty's failure, the receiver for the counterparty will refuse to recognize the validity of the netting provisions. In such an event, the receiver could ''cherry pick,'' or repudiate individual contracts under which the counterparty was obligated to pay the bank, while demanding payment on those contracts on which the bank was obligated to pay the counterparty. 

The Financial Institutions Reform, Recovery, and Enforcement Act of 1990 (FIRREA) and amendments to the Bankruptcy Code, as well as the payment system risk-reduction provisions of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), have significantly reduced this risk for financial institutions in the United States.2 The enforceability of close-out netting remains a significant risk in dealing with non-U.S. counterparties that are chartered or located in jurisdictions where the legal status of netting agreements may be less well settled. Significant issues concerning enforcement and collection under netting agreements also arise when the counterparty is an uninsured branch of a foreign bank chartered in a state, such as New York, that has adopted a ''ring fencing'' statute providing for separate liquidation of such branches. 

In evaluating the enforceability of a netting contract, an institution needs to consider a number of factors. First, the institution needs to determine the legal entity that is its counterparty. For example, if the bank is engaging in transactions with a U.S. branch of a foreign bank, the relevant legal entity generally would be the foreign bank itself. Additionally, some master agreements are designed to permit netting of transactions with multiple legal entities. A further consideration is the geographic coverage of the agreement. In some instances, bank counterparties have structured their netting agreements to cover transactions entered into between multiple branches of the counterparties in a variety of countries, thereby potentially subjecting the agreements to a variety of legal regimes. 

Finally, the range of transactions to be covered in a single agreement is an important consideration. While there is an incentive to cover a broad range of contracts to achieve a greater reduction of credit risk, over-inclusion may be counterproductive if contracts are included that jeopardize the enforceability of the entire agreement. Some institutions deal with this risk by having separate agreements for particular products, such as currency contracts, or separate master agreements covered by an overall ''master master'' agreement. 

Regardless of the scope of a master agreement, clarity is an important factor in ensuring the enforceability of netting provisions. The agreement should clearly specify the types of deals to be netted, mechanisms for valuation and netting, locations covered, and the office through which netting will be done. 

2. Risks related to netting enforceability have not been completely eliminated in the United States. Validation of netting under FDICIA is limited to netting among entities that may be considered to be ''financial institutions.'' 


Reliance on Netting Agreements 

While netting agreements have the potential to substantially reduce credit risk to a counterparty, an institution should not rely on a netting agreement for credit-risk-management purposes unless it has adequate assurances that the agreement would be legally enforceable in the event of a legal challenge. Further, netting will be recognized for capital purposes only if the bank has satisfied the requirements set forth in the Basle Capital Accord (the accord). To meet these requirements, the netting contract or agreement with a counterparty must create a single legal obligation, covering all transactions to be netted, such that the bank would have either a claim to receive or an obligation to pay only the net amount of the individual transactions in the event a counterparty fails to perform because of default, bankruptcy, liquidation, or other similar circumstances.3 Netting contracts that include a walk-away clause are not recognized for capital purposes under the accord. 

To demonstrate that a netting contract meets the requirements of the accord, the bank must have written and reasoned legal opinions that, in the event of a legal challenge, the relevant courts and administrative authorities would find the bank's exposure to be the net amount under- 

  the law of the jurisdiction in which the counterparty is chartered and, if a foreign branch of a counterparty is involved, then also under the law of the jurisdiction in which the branch is located; 
  the law that governs the individual transactions; and 
  the law that governs any contract or agreement necessary to effect the netting.4

Under the accord, the bank also must have procedures in place to ensure that the legal characteristics of netting arrangements are regularly reviewed in light of possible changes in relevant law. To help determine whether to rely on a netting arrangement, many institutions have procedures for internally assessing or ''scoring'' legal opinions from relevant jurisdictions. These legal opinions may be prepared by outside or in-house counsel. A generic industry or standardized legal opinion may be used to support reliance on a netting agreement for a particular jurisdiction. The institution should have procedures for review of the terms of individual netting agreements, however, to ensure that the agreement does not raise issues, such as enforceability of the underlying transactions, choice of law, and severability, that are not covered by the general opinion.

Institutions also rely on netting arrangements in managing credit risk to counterparties. Institutions may rely on a netting agreement for internal risk-management purposes only if they have obtained adequate assurances on the legal enforceability of the agreement in the event of a legal challenge. Such assurances generally would be obtained by acquiring legal opinions that meet the requirements of the Basle Accord.

 3. The agreement may cover transactions excluded from the risk-based capital calculations, such as exchange-rate contracts with an original maturity of 14 calendar days or less or instruments traded on exchanges requiring daily margin. The institution may consistently choose either to include or exclude the mark-to-market values of such transactions when determining net exposure. 
4. A netting contract generally must be found to be enforceable in all of the relevant jurisdictions for an institution to rely on netting under the contract for capital purposes. In some jurisdictions in which the enforceability of netting may be in doubt, however, an institution may be able, in appropriate circumstances, to rely on opinions that the choice of governing law made by the counterparties to the agreement will be respected. 

Multi-branch Agreements 

A multi-branch master netting agreement covers transactions entered into between multiple branches of an institution or its counterparty that are located in a variety of countries. These agreements may cover branches of the institution or counterparty located in jurisdictions where multi-branch netting is not enforceable, creating the risk that including these branches may render the entire netting agreement unenforceable for all transactions. To rely on the netting agreement for transactions in any jurisdiction, an institution must obtain legal opinions that conclude (1) that transactions with branches in user-unfriendly jurisdictions are severable and (2) that the multi-branch master agreement would be enforceable, despite the inclusion of these branches. 

Currently, the risk-based capital rules do not specify how the net exposure should be calculated when a branch in a netting-unfriendly jurisdiction is included in a multi-branch master netting agreement. In the meantime, institutions are using different practices, which are under review with the goal of providing additional guidance. Some institutions include the amount owed by branches of the counterparty in netting-unfriendly jurisdictions when calculating the global net exposure. Others completely sever these amounts from calculations, as if transactions with these branches were not subject to the netting agreement. With respect to transactions with branches in netting-unfriendly jurisdictions, some institutions add on the amounts they owe in such jurisdictions (which are liabilities) to account for the risk of double payment,5 while other institutions add on the amounts owed to them in such jurisdictions (which are assets). The approach an institution uses should reflect the specifics of the legal opinions it receives concerning the severability of transactions in netting-unfriendly jurisdictions. 

Collateral Agreements 

Financial institutions are increasingly using collateral agreements in connection with OTC derivatives transactions to limit their exposure to the credit risk of a counterparty. Depending on the counterparties' relative credit strength, requirements for posting collateral may be mutual or imposed on only one of the counterparties. Under most agreements, posting of collateral is not required until the level of exposure has reached a certain threshold.

While collateral may be a useful tool for reducing credit exposure, a financial institution should not rely on collateral to manage its credit risk to a counterparty and for risk-based capital purposes unless it has adequate assurances that its claim on the collateral will be legally enforceable in the event the counterparty defaults, particularly with respect to collateral provided by a foreign counterparty or held by an intermediary outside of the United States. To rely on collateral arrangements where such cross-border issues arise, a financial institution generally should have written and reasoned legal opinions that (1) the collateral arrangement is enforceable in all relevant jurisdictions, including the jurisdiction in which the collateral is located, and (2) the collateral will be available to cover all transactions covered by the netting agreement in the event of the counterparty's default. 

Operational Issues 

The effectiveness of netting in reducing risks also depends on how the arrangements are implemented. The institution should have procedures to ensure that the operational implementation of a netting agreement is consistent with its provisions. 

Netting agreements also may require that some of a financial institution's systems be adapted. For example, the interface between the front-office systems and back-office payment and receipt functions needs to be coordinated to allow trading activity to take place on a gross basis while the ultimate processing of payments and receipts by the back-office is on a net basis. In particular, an internal netting facility needs to- 

  segregate deals to be netted, 
  compute the net amounts due to each party, 
  generate trade confirmations on the trade date for each trade, 
  generate netted confirmations shortly after the agreed-on netting cut-off time, 
  generate net payment and receipt messages, 
  generate appropriate nostro and accounting entries, and 
  provide for the cancellation of any gross payment or receipt messages in connection with the netted trades. 

5. The risk of double payment is the risk that the institution must make one payment to a counterparty's main receiver under a multi-branch master agreement and a second payment to the receiver of the counterparty's branch in the netting-unfriendly jurisdiction with respect to transactions entered into in that jurisdiction. 

NON-DELIVERABLE FORWARDS 

An area of growing concern for legal practitioners has been the documentation of non-deliverable forward (NDF) foreign-exchange transactions. The NDF market is a small portion of the foreign-exchange market, but is a large part of the market for emerging-country currencies. An NDF contract uses an indexed value to represent the value of a currency that cannot be delivered due to exchange restrictions or the lack of systems to properly account for the receipt of the currency. NDF contracts are settled net in the settlement currency, which is a hard currency such as U.S. dollars or British pounds sterling. 

An NDF contract must be explicitly identified as such-foreign-exchange contracts are presumed to be deliverable. The index should be clearly defined, especially in countries in which dual exchange rates exist, that is, the official government rate versus the unofficial ''street'' rate. 

NDF contracts often provide for cancellation in the event of certain disruption events specified in the master agreement. Disruption events can include sovereign events (the nationalization of key industries or defaults on government obligations), new exchange controls, the inability to obtain valid price quotes with which to determine the indexed value of the contract, or a benchmark obligation default. Under a benchmark obligation default, a particular issue is selected and, if that issue defaults during the term of the contract, the contract is cancelled. Care should be taken to ensure that cancellation events are specifically described to minimize disputes as to whether an event has occurred. In addition, overly broad disruption events could cause the cancellation of a contract that both counterparties wish to execute. 

The International Swaps and Derivatives Association (ISDA) has established an NDF project to develop standard documentation for these transactions. The ISDA documentation establishes definitions that are unique to NDF transactions and provides sample confirmations that can be adapted to reflect disruption events. 

REVIEW OF LEGAL ISSUES 

Review by legal counsel, either in-house or outside the institution, should be an integral part of an institution's activities in the OTC derivatives markets. This review may take place at a variety of different levels. Some issues, such as documentation of transactions and the legality of OTC contracts, may be addressed appropriately on a jurisdiction-wide basis. Other issues, such as the enforceability of multi-branch netting agreements covering several jurisdictions or cross-border collateral arrangements, may require review of the individual contracts. The institution should have established procedures to ensure adequate legal review. For example, review by legal counsel may be required as part of the product-development or credit-approval process. Legal review also is necessary for an institution to establish the types of agreements to be used in documenting OTC derivatives, including any modifications to standardized agreements that the institution considers appropriate. The institution also should ensure that prior legal opinions are reviewed periodically to determine if they are still valid.

Legal Risk Examination Objectives 

1. To determine if the institution's internal policies and procedures adequately identify potential legal risks and ensure appropriate legal review of documentation, counterparties, and products. 

2. To determine whether appropriate documentation requirements have been established and that procedures are in place to ensure that transactions are documented promptly. 

3. To determine whether adequate assurances of legal enforceability have been obtained for netting agreements or collateral arrangements relied on for risk-based capital purposes or credit-risk management. 

4. To determine whether the operational areas of the bank are effectively implementing the provisions of netting agreements. 

5. To determine whether the unique risks of NDF contracts have been considered and reflected in the institution's policies and procedures, if appropriate. 

Legal Risk Examination Procedures 

The following should be used by examiners as guidelines to assist their review of the institution's trading activities with respect to legal risk. This should not be considered to be a complete checklist of subjects to be examined. 

1. Obtain copies of policies and procedures that outline appropriate legal review with respect to new products. 
a. Does the institution require legal review of new products as part of the product-review process? 
b. Do the procedures provide for review of existing products offered in new jurisdictions? 

2. Obtain copies of policies and procedures that outline review requirements for new counterparties.
 a. Does the institution require review of new counterparties to ensure that the counterparty has adequate authority to enter into proposed transactions? 
b. Do the institution's procedures ensure further review of counterparty authority if new types of transactions are entered into? 

3. Obtain copies of policies and procedures that establish documentation requirements. 
a. Has the institution established documentation requirements for all types of transactions in the trading area? 
b. When are master agreements required for OTC derivative or other transactions with a counterparty? 
c. Does the institution require legal review for new agreement forms, including netting agreements and master agreements with netting provisions? 
d. Who has authority to approve the use of new agreement forms, including new master agreement forms or agreement terms? 
e. How does the institution ensure that documents are executed in a timely manner for new counterparties and new products? 
f. Does the institution have an adequate document-management system to track completed and pending documentation? How does the institution follow up on outstanding documentation? 
g. What controls does the institution have in place pending execution of required documentation, such as legal-approval requirements, before the execution of master agreements or credit controls when documentation of collateral arrangements is not complete? Please note that documentation has not been executed until it has been signed by appropriate personnel of both parties to the transaction. 
h. In practice, is required documentation executed in a timely manner? 
i. Who has the authority to approve exceptions to existing documentation requirements? 
j. Do the procedures ensure that documentation is reviewed for consistency with the institution's policies? 
k. Who reviews documentation? 
l. Does the institution specify the terms to be covered by confirmations for different types of transactions, including transactions that are subject to master agreements? 
m. If the institution engages in NDF transactions, does the documentation address the index to be used and clearly specify that the contract is for a non-deliverable currency? Are disruption events, if any, described with specificity? 

4. Obtain copies of policies and procedures concerning review of enforceability of netting agreements and master agreements with netting provisions. 
a. Does the institution have procedures to ensure that legal opinions have been obtained addressing the enforceability of a netting agreement under the laws of all relevant jurisdictions before relying on the netting agreement for capital purposes or in managing credit exposure to the counterparty? 
b. Do the procedures include guidelines for determining the relevant jurisdictions for which opinions should be obtained? Opinions should cover the enforceability of netting under (1) the law of the jurisdiction in which the counterparty is chartered, (2) the law of any jurisdiction in which a branch of the counterparty that is a party to the agreement is located, (3) the law that governs any individual transaction under the netting agreement, and (4) the law that governs the netting agreement itself. 
c. When generic or industry opinions are relied on, do the procedures of the institution ensure that individual agreements are reviewed for additional issues that might be raised? 
d. Does the institution have procedures for evaluating or ''scoring'' the legal opinions it receives concerning the enforceability of netting arrangements? 
e. Who reviews the opinions? How do they communicate their views as to the enforceability of netting under an agreement? 
f. Who determines when master netting agreements will be relied on for risk-based capital and credit-risk-management purposes? 
g. Who determines whether certain transactions should be excluded from the netting, such as those in connection with a branch in a netting-unfriendly jurisdiction? 
h. When the institution nets transactions for capital purposes, are any transactions that are not directly covered by a close-out netting provision of a master agreement included? If so, does the institution obtain legal opinions supporting the inclusion of such transactions? For example, if the institution includes in netting calculations foreign-exchange transactions between branches of the institution or counterparty not covered by a master agreement, ask counsel if the institution has an agreement and legal opinion that support this practice. 
i. Does the institution have procedures to ensure that the legal opinions on which it relies are periodically reviewed? 
j. Does the institution have procedures in place to ensure that existing master agreements are regularly monitored to determine whether they meet the requirements for recognition under the institution's netting policies? 

5. Obtain copies of policies and procedures concerning review of the enforceability of collateral arrangements. 
a. Does the institution have guidelines that establish when and from what jurisdictions legal opinions must be obtained concerning the enforceability of collateral arrangements before the institution relies on such arrangements for risk-based capital or credit-risk-management purposes? 
b. Who reviews the opinions? 
c. Who determines when a collateral arrangement may be relied on by the institution for credit-risk-management or risk-based capital purposes? 
d. Do the procedures ensure that legal opinions relied on by the institution are reviewed periodically? 

6. Obtain samples of master agreements, confirmations for transactions under such agreements, and related legal opinions. 
a. Does the institution maintain in its files the master agreements, legal opinions, and related documentation and translations relied on for netting purposes? 
b. Have the master agreements and confirmations been executed by authorized personnel? 
c. Have master agreements been executed by personnel of the counterparty that the institution has determined are authorized to execute such agreements? 
d. Does the institution maintain records evidencing that master agreements and related legal opinions have been reviewed in accordance with the institution's policies and procedures? 

7. Obtain copies of the institution's policies and procedures concerning the implementation of netting arrangements. 
a. Do the procedures ensure that the terms of netting agreements are accurately and effectively acted on by the trading, credit, and operations or payments-processing areas of the institution? 
b. Does the institution have adequate controls over the operational implementation of its master netting agreements? 
c. Who determines whether specific transactions are to be netted for risk-based capital and credit-risk-management purposes? 
d. When is legal approval for the netting of particular transactions under a netting agreement required? 
e. How are the relevant details of netting agreements communicated to the trading, credit, and payments areas? 
f. How does each area incorporate relevant netting information into its systems? g. What mechanism does the institution have to link netting information with credit exposure information and to monitor netting information in relation to credit exposure information? 
h. Do periodic settlement amounts reflect payments or deliveries netted in accordance with details of netting agreements? 
i. How does the institution calculate its credit exposure to each counterparty under the relevant master netting agreements? 
j. If the master agreement includes transactions excluded from risk-based capital calculations, what method does the institution use to calculate net exposure under the agreement for capital purposes, and is that method used consistently? 
k. If a master agreement includes transactions that do not qualify for netting, such as transactions in a netting-unfriendly jurisdiction, how does the institution determine what method to use to calculate net exposure under the agreement for capital purposes? 

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