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Counterparty Credit Risk: The new challenge for global financial markets by Jon Gregory

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Introduction

THE NEW CHALLENGE FOR GLOBAL FINANCIAL MARKETS

In 2007 we started to experience what would be the worst financial crisis since the 1930s. The crisis spread from origins in the United States to become a global crisis. It also spread rapidly from the financial markets to have a significant impact on the real economy. Some financial institutions failed including the extremely high profile bankruptcy of the investment bank Lehman Brothers founded in 1850. Even more financial institutions would have failed were it not for government bailouts.

The first decade of the 21st century has been disastrous for derivatives and financial risk management. One area that needs special attention is that of counterparty credit risk, often known simply as counterparty risk. Counterparty risk arises from the credit risk in securities financing transactions such as repos and the vast and often complex OTC (over-the-counter) derivatives market. For example, Lehman Brothers had a notional amount of $800 billion of OTC derivatives at the point of bankruptcy. In addition, the complex web of transactions, collateral positions and structures such as SPVs (special purpose vehicles) needing to be unwound during the Lehman's bankruptcy has provided a reminder of the presence and complexity of counterparty risks within the financial system.

The use of derivatives among companies is widespread although the majority of the risk is centralised among financial institutions and further concentrated amongst ...

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