What is counterparty risk?

The meaning of counterparty risk in finance is that a trading partner fails while the deal is still open. The counterparty credit risk definition in Article 272(1) CRR reads: "the risk that the counterparty to a transaction could default before the final settlement of the transaction's cash flows". The Basel Framework adds that the concept rests on a "bilateral risk of loss": either side can end up owed money (CRE51.2).

The Basel Framework names the sources of counterparty risk in banking with four examples: a loan against collateral, a repo in which the bank posts securities for cash, a securities borrowing against cash, and a derivative such as a swap or an option. In a derivative, the value "can vary over time with the movement of underlying market factors" (CRE51.3). That is counterparty risk in derivatives: today the bank owes, next month it may be owed.

Counterparty risk is a form of credit risk in which the exposure runs both ways and moves with market prices. A loan exposes only the lender; the Basel Framework calls that exposure "unilateral" (CRE51.3). Set against credit risk in the narrow, loan sense, counterparty risk differs on five points.

Counterparty risk is a default before settlement; settlement risk is a failure at settlement, when one side has delivered and the other has not. The CRR sets capital for settlement risk in Part Three, Title V. For a trade still unsettled after its due date, Article 378 applies a factor to the price difference: 8% from 5 to 15 working days late, rising to 100% at 46 working days or more. Article 379 covers free deliveries, where a bank has paid or delivered before receiving the other leg.

Central clearing puts a central counterparty (CCP) between the two sides, so each trader faces the CCP. EMIR defines a CCP as a legal person that becomes "the buyer to every seller and the seller to every buyer" (Article 2(1)). Article 4 obliges counterparties to clear OTC derivatives of classes declared subject to the clearing obligation, for example between two financial counterparties.

The CCP collects margins that must cover losses from "at least 99 % of the exposures movements over an appropriate time horizon" (Article 41(1)). If a clearing member defaults, the CCP first uses that member's margins, then that member's default fund contribution (Article 45). For OTC derivatives that are not cleared, Article 11 requires daily mark-to-market valuation and a timely exchange of collateral.

Counterparty risk management sets a limit for each trading partner and measures the use of that limit. BaFin's MaRisk allows trades in principle only with counterparties that have a counterparty limit, and every trade with that party counts against it, including replacement and settlement risks (BTR 1). The Basel Committee approved guidelines for counterparty credit risk management in November 2024 and published them the following month. They respond to weaknesses that episodes of distress at non-bank financial intermediaries exposed (BIS, November 20, 2024).

Counterparty risk in cryptoassets is the risk that the exchange or custodian holding a client's coins fails. MiCA limits it: under Article 75(7), crypto-assets held in custody are legally segregated from the provider's estate, "so that creditors of the crypto-asset service provider have no recourse" to them in an insolvency. For banks, the Basel standard on cryptoassets notes that the redemption process of a stablecoin "may add counterparty risk that is not present in a direct exposure to a traditional asset" (SCO60.39).

In Germany and Austria, the CRR and EMIR apply directly. In Germany, the Bundesbank and BaFin share banking supervision, and MaRisk sets the limit process. In Austria, the FMA supervises banks with the OeNB (OeNB).

One such CCP is based in the Frankfurt area. Eurex Clearing AG is registered at the local court of Frankfurt am Main, has its offices in Eschborn and is supervised by BaFin as a credit institution (Eurex Clearing, imprint). It stands between buyer and seller and serves about 200 clearing members in 22 countries, clearing trades worth more than €11 trillion every month (Eurex Clearing).

Switzerland is outside the EU, so EMIR does not apply there. The Financial Market Infrastructure Act (FMIA), in force since January 1, 2016, has rules FINMA describes as very similar: clearing of OTC derivatives through a CCP (Article 97(1) FMIA), reporting to a trade repository (Article 104(1)) and risk mitigation for OTC derivatives (Article 107(1)) (FINMA Guidance 01/2016). This page gives no legal advice.