As the recent market crash have made painfully clear, any organization trading non-cleared OTC contracts is exposed to counterparty exposure, i.e. the risk that any of its counterparties fails to fulfill their obligations at some time in the future. To minimize this risk, the exposure towards each counterparty should be limited and monitored closely. Standard procedure is to categorize the counterparties according to their financial strength, e.g. class A, B, C, etc, and decide a set of limits for each category. Limits are typically set for P/L, position, and/or maximum time duration to expiry of the contracts.
All these cases are handled by Matrics in a straightforward manner. The exposure report will show the exposure for each counterparty and a flag for each limit that is broken. If a guarantor is registered for a contract, e.g. from a parent company guarantee, this is reflected in the report. The results will also account for the fact that physical contracts may not be netted in case of a default.
For each counterparty in the report there is a direct drill-down to all contracts with that counterparty. In addition to the full report, counterparty exposures are also directly available from the contract details window. These results include the effect of the current contract even if it is still only in a ‘draft’ state. This makes it easy for traders to check if any limits will be broken before entering into a new contract.
Simply considering the current P/L is not very satisfactory. Indeed, most contracts have a value close to zero when they are booked. Over time the exposure may get worse (worse in this context is counterparty owing us more money which would normally be considered better!). This may happen due to market movements, but it may also happen during the settlement of the contract. A yearly forward-settled FFA, for example, consists of 12 payments. If you have sold and the curve is falling, you expect to pay the counterparty for the first 6 months. Over the next 6 months the counterparty is expected to pay you back approximately the same amount. This is comparable to a loan, and the exposure will clearly be worst in mid-life of the contract.
Matrics can consider the combination of the worst possible time of default and the worst market movement among a set of pre-defined scenarios. The scenarios are the same user defined sensitivity scenarios used to monitor long-term market risk. By considering all these cases, Matrics will provide a much more realistic assessment of the worst possible loss for each counterparty. (The worst scenario and point in time will of course wary between the counterparties.)
