Managing Systemic Counterparty Risk through a Redesigned Financial Architecture

This article proposes a centralized financial utility that would mitigate systemic counterparty risk by guaranteeing against counterparty defaults and providing asset protection to its customers. The utility would hold collateral posted to it by each customer and issue secured counterparty risk bonds (CRBs). The fees paid to the utility by customers seeking counterparty risk protection would be paid as coupons to the CRB holders, and the principal would be repaid at maturity after subtracting any losses from counterparty defaults. This approach has numerous advantages, including creation of a market mechanism to mitigate systemic counterparty risk, protection of financial institutions from counterparty defaults, and enhancementstotheregulatory monitoring process. © 2009 CFA Institute.