What are the best practices for mitigating counterparty risk?

2 Diversify your exposure

Another best practice for mitigating counterparty risk is to diversify your exposure across different counterparties, sectors, regions, and products. This way, you can reduce the concentration risk and the impact of a single counterparty defaulting or underperforming. You should also balance your portfolio of assets and liabilities to avoid mismatched maturities, currencies, or interest rates. By diversifying your exposure, you can enhance your liquidity, flexibility, and resilience in the face of market volatility and uncertainty.

3 Use collateral and netting

A third best practice for mitigating counterparty risk is to use collateral and netting agreements with your counterparties. Collateral is a security or asset that is pledged or exchanged to guarantee the performance of a contract or transaction. Netting is a process of offsetting the mutual obligations between two or more counterparties to reduce the total amount of payments or deliveries. Both collateral and netting can help you lower your credit risk, improve your cash flow, and simplify your settlement process.

4 Implement risk limits and controls

A fourth best practice for mitigating counterparty risk is to implement risk limits and controls for your transactions and contracts. Risk limits are the maximum amount of exposure or loss that you are willing to accept for a given counterparty, product, or portfolio. Risk controls are the policies and procedures that you follow to measure, monitor, and manage your risk exposure. You should establish clear and consistent risk limits and controls that reflect your risk appetite, objectives, and capabilities.

5 Negotiate favorable terms and conditions

A fifth best practice for mitigating counterparty risk is to negotiate favorable terms and conditions for your transactions and contracts. Terms and conditions are the clauses and provisions that define the rights and obligations of the parties involved in a transaction or contract. You should aim to negotiate terms and conditions that protect your interests, such as early termination, default remedies, dispute resolution, and force majeure. You should also review and update your terms and conditions periodically to reflect any changes in the market or regulatory environment.

6 Seek external support and advice

A sixth best practice for mitigating counterparty risk is to seek external support and advice from professional and reliable sources. External support and advice can include legal, financial, or operational assistance, as well as risk transfer or mitigation solutions. For example, you can use third-party guarantees, insurance, or derivatives to hedge or transfer your counterparty risk to another entity. You can also consult with experts, advisors, or regulators to obtain guidance, insights, or recommendations on how to manage your counterparty risk effectively.