Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 24 manner. Additionally, various contract forms used in the industry allow for the margin posted, if it is cash, to be commingled with the requesting party’s funds. Therefore, we recommend the utilization of LOC capacity for those firms that would like to ensure the segregation of their collateral against rehypothecation for other collateral requirements. Generally, however, we believe that in today’s environment of tight capital and strained market liquidity, the industry must move beyond cash, parent guarantee, or LOC margining based on gross exposures towards other mitigation methods. 2.5 Exposure-Reducing Trades Exposure-reducing trades are transactions that are done in the marketplace, with a mutually agreed upon third party, for the purpose of transferring credit risk that exists between two parties from deals they have already transacted and placed in their portfolios. The credit exposure-reducing transactions are done simultaneously, such that the trading position of the three parties does not change — the economic benefit of the transactions is simply the movement of credit risk to a more acceptable counterparty. Note that these are not “sleeving” trades, in which parties which cannot transact with one another due to credit constraints inject a third party between them to “sleeve” the transaction. The greatest drawback to exposure- reducing transactions is if they are done when a counterparty’s credit status is rapidly declining and there is the risk of bankruptcy. In this case, creditors and bankruptcy trustees may challenge any and all of these transactions as “preferences” if done within the “preference window” as defined in bankruptcy law. (It is important to note that exposure-reducing trades are not the same as “wash” or “round-trip” trades in that they do have economic intent [reduction of credit risk] as a driver for the transaction.) 2.6 Master Netting Agreements Master netting agreements are one of the credit mitigation methods we strongly believe needs to be advanced in our industry. Bilateral standard master netting agreements are essential to a viable energy merchant industry. Netting generally occurs under two circumstances: close-out netting in the event of a termination, or netting of exposures for purposes of margining. The ability to net exposures across portfolios to mimic the true risk exposure that companies are managing is required as we go forward in today’s environment. It is important that the industry start using netting across commodities, across instruments (physical and financial), and across corporate entities. The power of such agreements has been theoretically proven by CRO analysis, and has also been practically proven via practice and implementation. More global use of bilateral master netting agreements could be accomplished via the codification of statutes and codes that would clarify the enforceability of such cross-product and cross-affiliate netting in the event of a bankruptcy event. The CCRO has also unanimously passed a resolution expressing interest in seeing laws changed to clarify the applicability of master netting agreements, not only across products and across instruments, but also across entities and geographic boundaries. The CCRO strongly supports the efforts by EEI to introduce a single-entity standard master netting agreement and credit support annex (described in Section III-1.0), and utilization of this