Five considerations when conducting a counterparty risk review

The current operating environment is unprecedented and many companies will be subject to increased financial and operational pressures. These pressures may lead to counterparties experiencing distress ranging from delayed payments for supply of goods to formal enforcement action. Conducting a review of your counterparties will allow you to understand how to best manage risk along the spectrum of financial hardship, minimise disruption to supply and optimise your financial position.

Counterparty risk considerations

Understand the contractual position
Where you have concerns in relation to your counterparty’s ability to fulfil obligations, you need to move swiftly. Understand your contractual position (including Force Majeure and Material Adverse Change clauses), the effectiveness of security held and the ability to request additional security. Where your counterparty has breached its contractual obligations you will have some more options to consider including a potential termination, acknowledging that the exercise of contractual rights may impact the broader customer relationship.

Consider the supply chain impact
Determine whether (and in what form) financial support is given to a distressed counterparty to avoid insolvency and protect supply. Supply chain disruption caused by distress of a counterparty may result in consequential losses to your business. Commence mitigation strategies and explore alternatives for supply to build further financial and operational resilience.

Review and consolidate internal processes
Corporates must have solid processes in place governing how they interact with distressed counterparties. A review can assess current systems and provide a road map on how to react in different circumstances.

Consider forbearance strategy
The forbearance path taken will depend on a number elements including; reliance on the counterparty, ensuring supply, minimising consequential loss to your business, and the findings of your counterparty risk assessment. These elements will allow for an informed decision to be made on whether a forbearance is appropriate, forbearance terms, and how to forbear.

Implement enforcement strategy
Consider the likelihood of a formal insolvency appointment to a counterparty, and the impact of different insolvency regimes on your position. Formal appointments will lead to a change in rights and obligations. A review of your supply chain and contractual landscape will inform how you can plan for and optimise your position in the event of a formal insolvency.

Manage risk along the spectrum of financial hardship