Counterparty Risk

Early 2025, EUR/USD was trading at 1.02. Many dollar buyers, fearing a move below parity, increased or extended hedging programmes.

Just three months later, following the announcement of wide-ranging US tariffs, EUR/USD was trading 15% higher, and those hedge trades were significantly underwater.

A recent failure

Argentex, a London-listed FX broker, had a large book of dollar buyers, having spent the latter part of 2024 highlighting the risk of EUR/USD parity to its clients.

As the dollar fell, Argentex was hit by margin calls from its own trading counterparties which quickly dwarfed the c. €18mn of cash held on its balance sheet. (We'll cover the cause in more detail in a separate article in this section).

Some 2,000 clients were affected by the collapse - some with account balances, but a larger portion with FX trades many of which had terms of one or two years or more.

We use the Argentex example here deliberately; it is relatively recent; but also because they are not a bank. The deposits weren't the main thing that was at risk, which is often the primary consideration when looking at credit risk.

Counterparty risk is often confused with credit risk, and credit risk is often simplified to loans and deposits.

But it's more than that.

• Deposits have protections that derivatives don't.
• Derivative exposure can be smaller, harder to measure, and fluctuates so often don't get the attention they deserve when credit risk is considered.
• Business continuity: Are you reliant on a single institution for funding lines, hedging facilities or any other services? What happens if they disappear?

The question you should be asking

• How much do I rely on this institution in totality?
• Will that institution survive?
• Can I replace them if they don't? and,
• Can my business survive if they don't survive and I can't replace them?

If the answers to those questions make you nervous, you need to look at diversification and contingencies.

Credit risk

Credit risk is still the core. It manifests itself in many different areas.

Ratings lag. Markets don't.

Credit Suisse carried investment-grade ratings to the day it collapsed. Its CDS spreads (Credit Default Swaps - the price markets pay to insure their bond investments in the case of a default) and share price had been screaming for months.

Likewise, financial analysis is always reliant on published, backward looking data. We cover market signals in more detail in their own article, and walk through the failures of SVB, Credit Suisse and Argentex as one syllabus: the signals, the causes and who was affected.

Your counterparty isn't just the name on the door

It is easy to assume every entity in a banking group carries the same risk. It doesn't. Large bank holding structures are complex, often deliberately. Much of the complexity exists to shift credit risk away from primary entities and conserve capital.

Always understand which entity you are facing, where they sit in the group, and how that affects their credit quality.

• A clear example of this is holding company debt generally ranks below operating entity debt, and usually incurs a 1-notch rating downgrade as a result.
• Likewise, branches, subsidiaries and SPVs may all get different credit treatment depending on whether they share the balance sheet of the rated entity, or if not, the extent to which guarantees and other credit support cover them.

If you carry risk to a different entity, not only will the main credit rating be stale, it may not be relevant, nor will the market indicators.

The relationship is also the risk

You can lose money on a counterparty and you can lose the counterparty.

The second costs real money too.

• Hedging lines withdrawn mid-programme mean replacing cover at whatever the market charges that week, or a delay in cover that leaves you exposed while rates move.
• A payments provider in distress means rerouting operational plumbing under pressure.
• A lender exiting your sector means losing access to undrawn facilities or refinancing on someone else's timetable.

A counterparty can disappear without failing. Strategic withdrawal from a market or business line, an acquisition, or loss of a key team.

It raises a separate set of questions;

• Are you dealing with a subsidiary or primary operating entity?
• Are your services a core part of their offering?
• Are you in one of their core geographies?

If the answer to any of these questions is No, your continuity risk is higher than an assessment of the primary bank entity suggests.

Brexit and a long list of strategic re-organisations have demonstrated that non-core teams and geographies get wound down or sold long before a stress scenario reaches the primary entity. They won't drag you into a resolution process, but they may force you to find an alternative provider.

How quickly can you replace a service?

The main measure of credit risk is how much you stand to lose.

The main measure for continuity is how quickly you can replace a service, and what it costs in the meantime.

• Signing up to a new payments provider can take a matter of days, most CFOs have the opposite problem, trying to avoid the constant sales calls and pitches from prospective providers. But migrating payment details, familiarising and integrating new systems and processes, and credit processes for larger deals can be more time consuming.
• Lending is a different story. Onboarding, credit, legals and documentation can be a time-consuming process, often taking months from initiation to draw-down. These things need proper planning and communication with counterparties. There are quicker alternatives for companies that need facilities, but you will pay for the convenience.

Counterparty risk is about understanding the credit risk you take facing your counterparty, how likely they are to be able to continue to service you, and how quickly you can replace that service.

The same job at three sizes