What Happens When a Counterparty Defaults on a Derivatives Contract?

When a counterparty defaults, the process depends on whether the trade is cleared or bilateral. If centrally cleared, the central clearing house (CCP) steps in, using the defaulter's posted margin to cover losses and ensuring the non-defaulting party's position is unaffected.

In a bilateral OTC trade, the non-defaulting party typically terminates all outstanding contracts with the defaulter. It then calculates its net losses based on market values and can seize any posted collateral.

Any remaining loss must be pursued through bankruptcy proceedings, which can be long and uncertain.