Define “Settlement Risk” in the Context of an Over-The-Counter (OTC) Derivatives Trade

Settlement risk is the risk that one party to a trade will deliver its obligation (e.g. the derivative contract) but will not receive the corresponding delivery from its counterparty (e.g. the payment). In OTC derivatives, this risk is heightened because trades are bilateral and not cleared through a central counterparty.

This can lead to significant financial loss if the counterparty defaults before settlement is complete.