A subcategory of legal risk that negatively impacts an entity’s management or transactions for reasons relating to legal capacity. The legal capacity risk (ultra vires risk) arises when a counterparty is, or becomes, not legally capable of effecting a binding, executable transaction. The negative impact of legal risk is represented in the potential losses to an entity from its inability to tackle proper execution of transactions or to comply with applicable policies and laws within a jurisdiction.

Ultra vires (Latin) is literally translated as ‘beyond the power/ powers’. However, in many cases it describes transactions which, although within the capacity of an entity, are carried out otherwise than through the proper exercise of the powers by an entity’s team/ management.

The ultra vires risk arises in dealing with public authorities (regulatory bodies, organized exchanges, etc.) For example, this risk is central to counterparties in the OTC derivatives market. In exchange derivatives markets with novation clearing (involving the replacement of an obligation to perform with a new obligation bearing identical or similar features), this risk is typically assumed by the contracting brokers.