Overcoming Challenges in Counterparty Risk Management

Abstract

We introduce a capture-analyze-manage framework to counterparty risk management. The constant risk aversion principle and a credit risk scoring system may help organizations establish a target risk level and proactively manage their positions as conditions change.

Introduction

Although it’s been five years since the Lehman Brothers’ bankruptcy, many corporate treasurers continue to feel uneasy about their exposure to financial counterparties which has become more complicated and weakened by the financial crisis of 2008 and government interventions thereafter. The crisis also resulted in fewer worthy counterparties and higher exposures for corporations. Adding to these difficulties is the age-old question of how to quantify, aggregate, analyze and proactively manage counterparty risk across an entire organization.
In this paper, we introduce a capture-analyze-manage framework of counterparty risk management to help corporations gain more insight on this topic and manage through volatile counterparty characteristics. We hope this framework, when combined with a credit scoring system, will simplify and standardize the risk management process to better effect.
Much of the material in the paper has been covered in our previous research papers. We refer our readers to these publications for more in-depth discussions. We believe the process discussed here will be especially helpful for treasury organizations with limited resources or capital markets expertise in a complex and interconnected world of finance.
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