-232- considered in determining credit risk. By ignoring these enhancements, a taxpayer such as FNBC fails to consider that a counterparty’s credit rating may actually be equivalent to an AA rating. 6. Netting The parties dispute whether netting applies in determining the fair market value of a swap. Respondent argues that it does. Petitioner argues that it does not. We agree with respondent. Market participants during the relevant years placed significant stress on the use of netting agreements, and most of FNBC’s swaps during those years were covered by ISDA agreements with netting provisions. Netting lowered FNBC’s credit risk in that FNBC, were it to be a nondefaulting party, could take advantage of offsetting transactions in the event of counterparty default. As a consequence of single- and multiple-transaction netting, when one swap is above market to the dealer and another swap between the same parties is below market to the dealer, credit exposure is reduced given that the corresponding obligations will be netted against one another. As a consequence of closeout netting, if one swap is above market to the dealer and another swap between the same parties is below market to the dealer, then in the event of default, the dealer’s potential loss will be limited because these obligations also will be netted against one another. Moreover, even when one of the parties to aPage: Previous 222 223 224 225 226 227 228 229 230 231 232 233 234 235 236 237 238 239 240 241 Next
Last modified: May 25, 2011