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Risk Management

Managing Counterparty Risk Easier Said Than Done

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July 13, 2017

Treasurers know that counterparty risk management is important. But often mechanics get in the way.

Falling dollarMost treasury teams understand the importance and benefits of a robust counterparty risk process. Nevertheless, implementation and ongoing execution of these processes can be challenging. At a recent meeting of the NeuGroup’s second Treasury Investment Managers’ Peer Group (TIMPG2) members, along with meeting sponsor Capital Advisors, discussed some of the issues they face.

Seemingly universally, corporate treasuries struggle with putting a counterparty risk management policy in place. Capital Advisors updated members on its approach to counterparty risk management using three overarching categories: capture, analyze and manage.

One of the first challenges in measuring counterparty risk, according to CA, is the aggregation of data – mainly because data are often spread over various systems. During the discussion, most members indicated that they cobble something together with Excel. While for most this is better than nothing, the process can be still be time consuming and susceptible to human error.

CA puts this under the capture category. It suggests investment managers aggregate counterparty holdings including money market fund security level detail using customized software and then sort and identify counterparty holdings and exposures in different ways.

CA gave examples of some of the questions counterparty risk management should address, including being able to identify what signals may indicate a problem, what issues that may be giving “false signals” and knowing what the threats as well as generally being environment-aware. That is, being prepared to act in certain circumstances. Also, to be reviewed: does your company have too much concentration in one name? And when aggregating, are all the data be considered, i.e., investments, bank accounts, bridge loans or other services?

For analysis, most processes rely on a few metrics such as ratings, CDS, and stock price. Although these metrics might not be aligned with the investment goals they are the most common and readily available. CA suggests to also if possible conduct credit research on counterparties and calculate an overall weighted counterparty risk score on the entire portfolio.

Manage by setting risk tolerances and view via the following three levels, CA says:
  1. Overall tolerance with the counterparty.
  2. Tolerance based on exposure type.
  3. Developing and executing policy.
CA says that setting policy tolerances across counterparties helps and then utilize risk metrics to identify “out of policy” counterparty exposures and in terms of execution, make buy/sell decisions to optimize and calibrate overall counterparty exposure using portfolio score.

Counterparty risk is different for everyone of course; every company has unique needs and vary on what they policies allow. But all companies though struggle on the “right” way to measure counterparty risk.

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