It stated there should be no financial rewards as part of the process.
The report, by an expert in conflict resolution, was requested by London and Dublin to gauge if the approach had "merit and support".
It recommended the governments set-up "a transition mechanism without delay".
Report author Fleur Ravensbergen met representatives of illegal loyalist and republican groups as part of a year-long scoping exercise.
She did not name precisely whom she met, citing confidentiality.
She also held talks with victims' groups and met the Police Service of Northern Ireland (PSNI), but said her report is not a security assessment.
'Inaction is not a neutral option'
Ravensbergen said among "stakeholders" there is "moderate but sufficient support" for the governments to explore "direct engagement" with paramilitaries.
But she stated the move should only happen if conditions are met.
She listed them as no financial rewards for paramilitaries; credible monitoring of progress; and robust law enforcement.
She said an independent, time-bound transition mechanism should be set-up without delay.
"I believe that the risks of the persistence of paramilitary structures, continued drift and unmanaged fragmentation outweigh the risks associated with attempting a structured and time-bound transition process.
"Inaction is not a neutral option.
"My consultations suggest that a window of opportunity exists to pursue further progress, but that this may weaken over time.
"None of the paramilitary groups I engaged with brought up direct financial payments or early release from prison as a condition of transition or of accelerating progress towards it."
NI secretary to 'carefully consider' recommendations
The Secretary of State for Northern Ireland, Sir Chris Bryant, said: "Everybody in Northern Ireland has a right to live free from fear and intimidation. The continuing existence of paramilitary groups poses a direct threat to that right."
Sir Chris said he was "pleased" the report "identifies possible routes to end paramilitarism".
He added that he "will take time to carefully consider and discuss" the report.
"The main recommendation, detailing a possible mechanism for transition of paramilitary groups, is clear that any process must be complementary to existing efforts and accompanied by a robust criminal justice response.
"It is evident from the report that the implementation of any process will face challenges and will need the support from across the political community in Northern Ireland."