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II. Credit Risk Management
Up-Front Risk Assessment
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section of a derivatives agreement provides an important tool for assuring that the general credit risk is considered and that the counterparty supports the underlying financial data on which an assessment is made. Provision is made for updating the up-front assessment by requiring satisfaction of the relevant conditions precedent in all subsequent transactions. Common conditions precedent include the following:
- Document Delivery to Address Credit Risk This condition requires delivery of documents relating to the counterparty´s financial condition, including financial statements and any related audit reports, Securities and Exchange Commission or other regulatory filings, and documents tailored to particular concerns such as credit exposure to third parties (e.g., bank loan agreements) or material litigation.
- Representations Addressing Credit Risk This condition requires that the counterparty´s representations and warranties are accurate (and are deemed made or repeated) at the time of entering into a transaction. The relevant representations and warranties include the accuracy and completeness of documents delivered regarding the counterparty´s financial condition, absence of material adverse changes, and absence of events that would constitute defaults.
- Representations Addressing Enforceability Representations also address enforceability risk through representations relating to (1) the counterparty´s existence and power (internal and pursuant to applicable laws) to conduct the business and engage in the transaction; (2) authorization, execution, and delivery of the agreement; (3) the validity, binding nature, and enforceability of the agreement as against the counterparty; and (4) absence of conflicts with the counterparty´s constituent documents, material contracts, or applicable laws. It should be noted that if a party does not have the power to enter into a derivatives transaction because the transaction is ultra vires, a representation cannot cure the problem.
- Document Delivery to Address Enforceability Conditions precedent relating to document delivery also address enforceability risks. Commonly, this is done through requirements that a counterparty deliver a secretary´s certificate (covering authorization, constituent documents, etc.), an incumbency certificate, and a legal opinion (which may be internal or external). Although these documents are typically required up front by master agreements, such documents typically are not required to be updated for subsequent transactions.
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II. Credit Risk Management
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