A Decade After 2008, Counterparty Risk is a Growing Concern
One of the great lessons we learned from the 2008 financial crisis was that the world is not as safe as we often think. That’s as true today as it was then, even after extensive industry and regulatory efforts aimed at the financial system. Corporate cash investors are confronting a financial landscape that’s even more complex than a decade ago. New risks lurk in the form of further consolidation among major banks, ongoing proliferation of complex financial instruments, new global interdependencies, and growing exposure to indirect financial and trading partners.
Corporate treasury departments are starting to take a new, more systematic approach to counterparty risk management. Counterparty risk refers to exposures to parties in contracts that may not fulfill their contractual obligations. It is essentially a form of indirect credit risk, different from direct risk from unsecured borrowings, such as bonds and deposits. Managing counterparty risk proactively may give you the heads-up you need to help avoid future losses from those indirect exposures.
If we learned anything in 2007 and 2008 from the early warnings emanating from Lehman Brothers and other major financial institutions, it’s that where there’s smoke, there’s often fire. Corporate treasurers responsible for managing institutional cash are by necessity adept at monitoring exposure of their direct investments in Treasuries, bank deposits, money-market funds and other short-term assets designed to provide liquidity. Very often they invest less time in systemic management of counterparty risk. But forward-looking risk management may help flag the kinds of early warning signs—especially from financial institutions that in the past were deemed “too big to fail”—that many cash investors missed in 2008.
Our new research report, Counterparty Risk Management for Corporate Treasury Functions, is a helpful guide for institutional cash managers who want to start taking a more proactive role in managing counterparty risk. The white paper is designed to help set corporate and treasury organizations on the path to an integrated policy across business lines that can diversify risk by setting exposure limits according to multiple, interrelated risk criteria. As we learned a decade ago, an ounce of prevention can be worth more than a pound of cure.