How Can Using a Counterparty’s Own Stock as Collateral Create Wrong-Way Risk?

Using a counterparty's own stock as collateral creates specific wrong-way risk because if the counterparty defaults (e.g. goes bankrupt), the value of its stock will likely drop dramatically, or become worthless, at the exact moment the firm needs to liquidate the collateral to cover the default loss. The collateral's value and the counterparty's credit quality are positively correlated with loss.