Quick answer: Counterparty risk is the chance that the other side of a hedge fails to meet its obligations, which can undermine the protection a hedge is meant to provide. Firms manage it through credit assessment, collateral and margin, netting agreements, and diversification across counterparties.

Why does counterparty risk matter?

A hedge only works if the counterparty performs. If it defaults, the company can be left exposed exactly when protection is needed, which is why counterparty risk is a core concern in natural gas hedging and in risk management strategies.

How is counterparty risk assessed?

Firms evaluate counterparties' creditworthiness using financial analysis and ratings, then set exposure limits. Exchange-traded futures reduce this risk through central clearing, while over-the-counter deals carry direct counterparty exposure.

How is it mitigated?

Key tools include collateral and margin, netting and ISDA agreements, and diversification across multiple counterparties. Mobius Risk Group's commodity credit and counterparty risk management services help firms manage exactly these exposures.

Frequently asked questions

What is counterparty risk in hedging?

The risk that the party on the other side of a hedge fails to perform, potentially leaving the company unprotected.

How do futures reduce counterparty risk?

Exchange-traded futures are centrally cleared, so the clearinghouse stands between parties, greatly reducing direct counterparty exposure.

How is OTC counterparty risk managed?

Through credit assessment, collateral and margin, netting agreements, and diversifying across counterparties.