Counterparty Exposure

Counterparty exposure represents the total amount of risk a participant has to a specific counterparty in a trade. If the counterparty fails to perform, the exposure is the amount that could be lost.

In bilateral over-the-counter derivatives, exposure is significant because there is no intermediary to guarantee the trade. In exchange-traded or cleared derivatives, exposure is limited to the clearinghouse.

Managing exposure involves diversifying trades across multiple counterparties and using collateral to offset potential losses. High exposure to a single entity, especially one with poor financial health, is a major source of systemic risk in financial markets.