Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 9 III CONTRACTS 1.0 Contract Uses and Types Although a thorough, accurate, and well-constructed credit analysis can provide the credit department with sufficient comfort to assign an unsecured credit limit, the counterparties may give up some or all of their rights if the proper contractual arrangements are not fully executed. As a best practice, trading should not commence before having fully executed contracts. Companies should execute a master agreement containing netting, set-off, cross-default, close- out, and margining provisions governing all financial transactions and a master agreement governing all physical transactions with respect to the same commodity. There are a number of different standard product contracts. The use of these standard product contracts creates a more efficient market, lowers the barrier for a broader group of participants, and provides more standard terms. Master agreements that are widely adopted and well evolved include: • International Swap Derivatives Association Inc. ― Master Agreement (ISDA) • Edison Electric Institute ― Master Purchase & Sale Agreement (EEI) • Western Systems Power Pool – Western Systems Power Pool Agreement (WSPP) • North American Energy Standards Board ― Base Contract for Sale and Purchase of Natural Gas (NAESB) • Gas Industry Standards Board ― Base Contract for Short-Term Sale and Purchase of Natural Gas (GISB) The ISDA and the EEI are the recommended contract structures for financial trading (of any commodity) and power, respectively, because of their widespread use and acceptance among market participants. Also, for power, the WSPP is another widely used contract that incorporates some credit protection measures, although it is not as clear and concise as the EEI. For gas, the NAESB, which contains netting provisions and is a newer product, is a stronger contract than the base GISB, but the GISB’s evolution within many companies (special provisions, added language, etc.) can make it comparable to the NAESB. Margining is a preferred method of securing credit risks. The ISDA and the EEI have developed credit support annexes that provide robust and well-defined procedures for the exchange of collateral. The use of the credit support annex under the ISDA and the EEI is considered a best practice to gain the ability to manage credit quality. While the base EEI has margining provisions, they do not clearly define exposure, margining rights or the transfer, holding, use, or return of collateral. Therefore, the recommended approach is to use the EEI Credit Support Annex. The WSPP is in the process of developing credit terms similar to the EEI Credit Support Annex. The GISB contract is commonly used for short-term physical gas sales. Although the NAESB contract was developed to govern both short-term and long-term gas sales, it does not contain