Counterparties are those entities on the other side of a financial transaction or exposure. This can be the other party to an FX trade, a bank who holds your balances or even a large customer.
Ongoing vigilance and diligence is in order here. Well, more than in order. It is required. Life would be a lot easier if counterparty failures began announcing themselves loudly several months ahead of time – and increased the volume as a failure or impairment got closer that might make things easier. Situations can deteriorate over time and then often seem to turn ugly very quickly.
The graphic shows a sample of four different ‘fails’ from the start of the financial crisis to some happening this fall and even today. There are many more that could be listed (including several hundred US banks that have been shuttered or absorbed) during this time.
Complexities abound with Counterparty risk monitoring and calibration. Let’s touch upon a few of these ideas.
- Hierarchy. Many companies are owned by others. You can have overlapping exposures and not know it. That can and must be stopped. This month, if not today.
- Rule Changes. The rule of law is a good thing. It offers a level of consistency and that is good for many things including a free economy. Rules can change. Ask GM bondholders whose priority was changed by government action. Care is required. Rules can change with treasurers too. A number of firms used to invest in Auction Rate Securities WITHIN the limitations of their investment policy. When those markets seized up, some treasurers were fired.
- CAREFUL with NAMES. If you buy a credit default swap (CDS) and think you are covered nicely that may or may not be correct. You must make sure that your counterparty is the same counterparty named in the CDS. Did you mean to buy coverage on the bank or its parent, the bank holding company? Saying “I meant to…” won’t settle your claim.
It can often seem that there is a lull in the storm and Treasury can let their guard down. Counterparty risks need to be monitored. This is relatively obvious of course. You also need to calibrate that risk that takes into account, size of risk , direction of risk and the speed that risk is changing. Doing this effectively is not as easy as simply buying a service one afternoon and you are all set. However, today, it is far easier than it used to be to simply monitor your bank balances globally. Let’s get moving.








