Standard & Poor’s has issued a report which reiterates that one of the key exposures in a securitization transaction (that includes insurance-linked securitization through catastrophe bonds) is counterparty risk. The risk of a counterparty being unable to meet its obligations within a transaction is central to S&P’s analysis of creditworthiness.
In recent years a lot of focus within the catastrophe bond area of securitization has been on collateral risk, but often the real risk to collateral is actually the risks associated with the counterparty who could be providing that collateral (Lehman Brothers as an example).
S&P say that the financial disruptions of the last few years have reiterated that this is a risk that cannot be ignored and they stress that counterparty risk should not be overlooked. “Under stressed conditions there is a risk that a counterparty might not perform its duties, which, in some cases, could lead to a payment default on the securities,” said credit analyst Andrew South.
Insurance-linked securities issuers have been making good progress dealing with collateral risks by utilising highly rated government securities for this purpose. However there can never be 100% certainty that collateral or any counterparty involved in a transaction is safe so it is an essential part of due diligence to make efforts to reduce both collateral and counterparty risk as much as possible.
Andrew South concluded; “Even as the securitization market recovers, and structures begin to evolve to reflect lessons learned, we believe that counterparty risk is likely to remain an important consideration in determining the creditworthiness of structured finance securities.”