Credit risk mitigation technique

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CRM techniques under the Basel Standardised Approach to Credit Risk framework are broken down as follows:

Now note a fundamental difference between legally enforceable netting arrangements and Guarantees: In a netting arrangement the full value of the offsetting transaction fully and automatically cancels out the corresponding exposure. There are no contingencies. By contrast, collateral arrangements that don’t amount to enforceable netting arrangements, guarantees and CDS transactions all depend for their effectiveness on the solvency of the person providing the credit mitigation – if the credit support provider fails, so does the credit mitigation and the exposure remains.

Credit risk mitigation against exposure negation

Note the difference between techniques which mitigate a credit risk that you nonetheless have — as above — and those which negate the credit exposure in the first place.

So, par example:

References

  1. This is what it says, and I suppose it is true, even though “hedging” is a curious way of describing it.
  2. In many cases (e.g. the ISDA Master Agreement a collateral arrangement will be delivered under a “transaction”, and so will explicitly be a master netting arrangement.
  3. Do not get me started on rehypothecation.
  4. Assuming you get the legals right...