The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Counterparty Risk Methodology
Counterparty Risk Methodology
Foreword
Introduction
Theory and Practice of Corporate Risk Management
Theory and Practice of Optimal Capital Structure
Introduction to Funding and Capital Structure
How to Obtain a Credit Rating
Refinancing Risk and Optimal Debt Maturity
Optimal Cash Position
Optimal Leverage
Introduction to Interest Rate and Inflation Risks
How to Develop an Interest Rate Risk Management Policy
How to Improve Your Fixed-Floating Mix and Duration
Interest Rates: The Most Efficient Hedging Product
Do You Need Inflation-linked Debt?
Prehedging Interest Rate Risk
Pension Fund Asset and Liability Management
Introduction to Currency Risk
How to Develop Currency Risk Management Policy
Translation or Transaction: Netting Currency Risks
Early Warning Signals
How to Hedge High Carry Currencies
Currency Risk on Covenants
Optimal Currency Composition of Debt 1: Protect Book Value
Optimal Currency Composition of Debt 2: Protect Leverage
Cyclicality of Currencies and Use of Options to Manage Credit Utilisation
Managing the Depegging Risk
Currency Risk in Luxury Goods
Introduction to Credit Risk
Counterparty Risk Methodology
Counterparty Risk Protection
Optimal Deposit Composition
Prehedging Credit Risk
xVA Optimisation
Introduction to M&A-related Risks
Risk Management for M&A
Deal-contingent Hedging
Introduction to Commodity Risk
Managing Commodity-linked Revenues and Currency Risk
Managing Commodity-linked Costs and Currency Risk
Commodity Input and Resulting Currency Risk
Offsetting Carbon Emissions
Introduction to Equity Risk
Hedging Dilution Risk
Hedging Deferred Compensation
Stake-building
As mentioned in Chapter 26, counterparty risk is the risk that one counterparty may default on their obligation to another. Companies experience it in many ways (for example, through the risk on their suppliers or clients), but here we focus on the risks from their banking counterparties through bank deposits and derivatives.
In this chapter, we will discuss how to develop a risk management policy for derivative counterparties. Through it, a company could optimise its derivative portfolio in several ways:
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by reducing the potential exposure to selected banks;
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by freeing-up credit lines through combining potential offsetting derivatives; or
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by reducing the transaction cost (eg, credit, capital and funding charges – the so-called xVA) on new trades via implementing various credit mitigants.
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Immediately after the credit crisis in 2008/9, companies became concerned about the first of these topics: credit exposure to their banking counterparties. Latterly, as credit lines became scarcer and xVA went up, the second and third topics have been an increased focus of corporate treasurers, especially for their longer-dated transactions
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