For Business

Risk & Money Management

What Is Counterparty Risk

Counterparty risk is the chance that the firm on the other side of your trades, the broker, cannot pay what it owes, so that a deposit and every profit not yet withdrawn are claims on it rather than money. This paper shows you the trader's money line by line in example figures, with what is held on the broker's side; the idea as a cloakroom ticket, a claim on a coat behind someone else's counter; the chain of firms behind a trade; the umbrella of a compensation scheme where one exists, and segregation of client money; and the company name at the top of the Accounts tree on your platform, which is the counterparty's name.

Difficulty
Advanced
Reading time
5 min
Pages
8
Reviewed by
Saman Rahbar

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The trader's money, line by line

Every trade on a retail platform is a contract with the broker, and the broker is the counterparty, the other side, to all of it. Take an example account: a 10,000-dollar deposit held in the broker's bank, an open trade showing 300 dollars of profit, and 500 dollars of closed profit not yet withdrawn. The deposit is the broker's to hold; the two profits are claims on the broker, not yet money. A withdrawal that has arrived is in the trader's own bank and is no longer at risk. Counterparty risk is the chance that the firm cannot pay those claims, and if it fails, what is at risk is everything still on its side of the line.

A cloakroom ticket

Picture a cloakroom. The coat is handed over the counter and a ticket is handed back; the ticket is a claim on the coat, not the coat, and it is worth exactly what the cloakroom's promise to return the coat is worth. A trading account is that ticket. The balance on the screen is a number the broker prints; the money it stands for is in the broker's bank, behind the broker's counter, alongside other people's coats. While the cloakroom is open the ticket is as good as the coat. If it closes, the ticket is a piece of card, and the coat is wherever the closing left it.

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