What is Counter Party Risk?

There is a big difference between counter-party risk and
performance risk. In today’s uncertain financial environment avoiding counter-party risk wherever possible is prudent.

Wealth can take two forms as either a tangible or financial asset. By extension currency can be either money or a money-substitute. The value of financial assets is ultimately tied to some-one’s promise and their financial capacity to fulfill that promise. Thus financial assets, such as checking, saving and sweep accounts, stocks, bonds and federal reserve notes (USD or EUR) are subject to counter-party risk.

Cash (currency) can be either a money which must be a tangible asset (gold) or a money substitute which is a financial asset (US$, Euro, Pound, etc.).

Counter-Party (Credit) risk is the risk of loss due to a debtor’s non-payment of a loan or other line of credit - either the principal or interest (coupon) or both. For example, when a Euro note is deposited into a bank account the depositor becomes an unsecured creditor of the bank and the value of that Euro is equal to one Euro minus the counter-party (credit) risk of the bank. The price of the Euro may still be a Euro.

By contrast tangible assets have intrinsic value and can never be worthless. If you own a tangible asset such as gold there are two ways to hold it. Either store it yourself or work with a custodian to store it for you.

But do custodians of tangible assets held in allocated storage have counter-party risk?

The answer is NO if the contract is constructed properly. However, their customers do have performance risk. The customers accept the custodian’s promise to complete expected tasks.




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