Explain the Concept of "Settlement Risk" in Bilateral Over-the-Counter (OTC) Derivatives Trading ▴ Learn

Explain the Concept of “Settlement Risk” in Bilateral Over-the-Counter (OTC) Derivatives Trading.

Settlement risk is the risk that one party fails to deliver the assets or cash as agreed upon after a trade has been executed. In OTC derivatives, this is particularly relevant because the trade is bilateral and often lacks a central clearing counterparty (CCP).

If a counterparty defaults between trade execution and settlement, the solvent party faces a potential loss. Delivery Versus Payment (DVP) mechanisms are used to mitigate this risk.

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