Many companies have warehoused large amounts of unwarranted credit risk. There are many forms of credit risk and it is essential for companies to set up systems that measure and quantify each operation’s inherent credit risk. A centralised risk management system will aggregate risks across different business lines for each counterparty. Credit derivatives are becoming more popular and provide users with more transparent, tradable, liquid and standardised contracts. They can also pay out and settle without the buyer having to prove financial loss. Credit default swaps – the underlying contracts in most credit derivatives – pay out if the reference entity suffers a ‘credit event’ such as bankruptcy. Companies with a good understanding of the credit risks that affect their businesses, and who manage them with credit derivatives, can make considerable long-term cash savings.
