Mitigating Counterparty Credit Risk In The OTC Derivatives Market
Mondaq Business Briefing › Switzerland Law Articles in English (2011)
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Mitigating Counterparty Credit Risk In The OTC Derivatives Market
Introduction
Counterparty or credit risk exists whenever a market participant has entered into a transaction with a counterparty where the latter has an obligation to make payments or deliveries at some point in the future. Except for some regulated entities such as banks, securities dealers, investment funds or other collective investment schemes and pension funds, which are required by law to monitor and limit their counterparty exposure generally or at least for certain types of transactions, market participants are in general free to assume unlimited counterparty risk at their discretion, whether under over-the-counter (OTC) derivative transactions or otherwise. Thus, unless market participants are subject to specific laws or regulations or are bound by contractual arrangements, they are free to choose whether, how and to what extent they wish to limit or mitigate their counterparty risks. However, as a result of the recent credit crisis, most sophisticated parties which are aware of the extent that their trading volume is sufficient to warrant the respective costs – mainly legal expenses associated with the negotiation and maintenance of the necessary documentation, operational and technology costs, custody fees and financing costs associated with transferring, receiving and monitoring collateral – as a first step opt to enter into master agreements with their counterparties in order to reduce their exposure to a net amount. In a secon...See the full content of this document
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