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Member question: “For companies that trade derivatives on a non-collateralized basis, how do you measure your exposure to counterparties on outstanding trades (e.g., impact from one standard deviation movement?) and how is this factored into your overall counterparty risk assessment?
- “We are currently looking to move away from collateral postings on our derivative trades. In order to do so, we want to ensure we first have a methodology in place for calculating and managing the additional exposure this would create with banks we trade with.
- “Also, we’re looking to determine the process for consolidating this derivative exposure along with other exposures we have with these banks (e.g., bank deposits).”
Peer answer: “Most of our hedges are relatively short-dated. For our longer-tenor trades, we deliberately diversify across many banks.
- “Currently, we’re a bit simple in that we view counterparty risk on the trades based on notional outstanding and mark to market, and only focus on derivatives—at least for now. Quarterly, we review the credit ratings and collateralized debt securities for our counterparty banks.”
NeuGroup Insights: The peer answering the question also brought up a presentation at a NeuGroup meeting last fall where members heard about “an outstanding way of measuring/monitoring counterparty risk” from one of their peers.
- You can read our article about this proactive approach to measuring and managing FX and other counterparty exposures, “An Early Warning System to Flag Excessive Counterparty Credit Risk,” by clicking here.