Counterparty risk
Counterparty risk is inherent all over the business world, not just trading. It is the risk the counterparty you are transacting with can’t or won’t pay what is due or deliver what they owe. For example, holidaymakers experience the downside of counterparty risk if their travel agent goes bust and they can’t go on the holiday they paid for.
The same risk exists in trading and it the risk the entity you’re trading with – your broker – does not pay your deposit or your profits back. Remember – if you lose money trading it becomes the brokers at that point so we’re not talking about that here. The obvious reason for non-payment is if the broker goes bust but occasionally we hear of unregulated brokers just plain refusing to send deposits back.
Managing counterparty risk
Given it is very difficult to find out the day to day risks taken on by the broker you trade with, regulation plays a big role here. In our course on Understanding Brokers, there is a lesson on Regulation.
Well regulated brokers will have in place very strict rules, processes and be able to back it up with a strong balance sheet for the risks they take on. Occasionally, even following all these rules, a broker can go bust – see what happened to Alpari after the Swiss Franc unpegging. Well developed jurisdictions have fallback schemes, like the FSCS in the UK, where traders that end up losing their funds via a bankruptcy are covered up to point.
- Counterparty risk is the risk that the entity you’re trading with can’t or doesn’t pay.
- Counterparty risk can never be eliminated but it is managed by going with a well-regulated broker.
