The International Swaps and Derivatives Association (ISDA), the London Investment Banking Association (LIBA) and The Bond Market Association (TBMA) yesterday issued a detailed set of recommendations concerning the counterparty risk treatment of OTC derivatives and securities financing transactions.

The recommendations are based on extensive research spearheaded by the ISDA Counterparty Risk Working Group (CRWG), focusing on methods of measuring potential future exposure used by member firms for the purpose of calculating economic capital assigned against OTC derivative and securities financing transactions.

ISDA, LIBA and TBMA launched a survey of counterparty risk measurement practices, whose terms were discussed and agreed upon with the Basel Committee's Models Task Force (MTF). This survey shows that a majority of respondents use Expec ted Positive Exposure (EPE) based measures of future exposure to calculate economic capital. The survey also confirms the findings of the ISDA Margin Survey, showing increasing use of collateral against OTC derivatives positions.

The CRWG furthermore continued to analyze and refine the assumptions underlying its initial proposal (see www.isda.org, ISDA's response to the Second Consultation Paper issued by the Basel Committee on the New Capital Accord, May 2001). This was promp ted in part by feedback from regulators, including the analysis of its proposal by the Federal Reserve Board.

The Associations understand that the MTF intends to review the capital treatment of counterparty risk soon after the adoption of the New Accord, with a view to implementing any necessary changes at the same time as the Accord itself if possible. The Associations strongly support this objective and have stressed in their recommendations the need for reviewing the capital treatment of OTC derivatives and securities financing transactions (SFTs) jointly, considering that SFTs, like many OTC derivative transactions, involve the transfer of collateral, and are utilized by market participants for many of the same purposes, in particular to manage risk. As such, securities financing transactions are increasingly managed together with OTC derivatives under cross product netting agreements.