This counterparty risk is compounded by the complete lack of transparency in OTC derivatives markets. Since these markets are opaque, it is difficult to properly assess the risk of dealing with a given counterparty, especially when that party is dealing with other companies.  This opacity, because of its unpredictability, makes it very difficult to use counterparty risk accurately in the markets.  This story shows how derivatives can shift the risk (and associated rewards) from risky downpours to those at risk. Although Warren Buffett once referred to derivatives as “weapons of financial mass destruction,” derivatives can be very useful tools, as long as they are used correctly. Like all other financial instruments, derivatives have their own advantages and disadvantages, but they also have a unique potential to improve the functionality of the entire financial system. The framework contract is quite long and the negotiation process can be laborious, but once a framework contract is signed, the documentation of future transactions between the parties will be reduced to a brief confirmation of the essential terms of the transaction. Conversely, derivatives traded on the stock exchange are standardized and more regulated. The main credit support documents subject to UK law are the 1995 Credit Support Annex, the 1995 Credit Support Deed and the 2016 Credit Support Annex for Variation Margin. Support credits ancillary to English law provide guarantees for the transfer of ownership, while English Credit Support Deed provides for the granting of a guarantee right on the transferred guarantees. The Credit Support Annex 2016 for Variation Margin was specifically introduced to enable parties to meet their Margin Variation exchange obligations in compliance with margin rules worldwide, including EMIR in Europe and Dodd-Frank in the United States of America.
The annexes to credit assistance under English law are confirmations and the transactions they constitute are transactions under the framework agreement and therefore form part of the special contract with the framework agreement. On the other hand, the English Credit Support Deed is a separate agreement between the parties. Derivatives can be traded on a line of credit (OTC) or on an exchange. OTC derivatives represent a larger share of the derivatives market. In general, derivatives traded in OTC contracts are more likely to have counterparty risk. Counterparty risk is the risk of a default by one of the parties to the transaction. These parties act between two private parties and are not regulated….