Education
Counterparty risk: what happens if your execution provider goes under
The four risks you take on by concentrating your execution in one entity, how to assess them before signing, and why fund segregation matters more than any clause in the contract.
In January 2015 the Swiss National Bank removed the franc's cap against the euro. Within minutes, brokers with years of operation were left with negative equity, and several of their clients discovered their funds weren't where they thought.
That episode is still the best lesson available on counterparty risk, and most of the agreements signed today don't reflect having learned it.
The four risks
When you concentrate your execution in one entity, you take on four distinct risks worth not confusing with one another.
1. Credit risk
That the counterparty can't return what it owes you: your funds, your positions, your unwithdrawn gains.
It's the obvious risk and the least understood, because it depends almost entirely on one technical detail: whether your funds are segregated or not.
2. Operational risk
That the counterparty stays solvent but stops functioning: a prolonged outage, a failed migration, a security incident.
Less catastrophic than the previous one, but more frequent. And in a moment of volatility, not being able to execute for two hours can cost as much as an insolvency.
3. Regulatory risk
That the counterparty loses its license, is sanctioned, or is found operating outside its authorized scope.
This is the one most underestimated. If the regulator suspends your provider, your operation stops even though the entity is solvent and its systems work.
4. Concentration risk
That all of the above hits you at once because you have a single relationship.
Fund segregation, which is what really matters
If you had to evaluate a single thing, it would be this.
Segregated funds means your money is held in accounts separate from the entity's own assets, at top-tier banks, and isn't used to finance its operations. In the event of insolvency, those funds aren't part of the insolvency estate: they're yours.
Non-segregated funds means you're just another creditor. You'll get in line, behind the privileged creditors, and collect whatever's left.
The difference between the two situations is, literally, the difference between recovering your money and not recovering it.
Ask specifically: at which bank are the segregated funds held? How often are the accounts reconciled? Who audits that reconciliation?
A serious entity answers all three without evasion. Note too whether segregation appears as a condition of its license — not just as a commercial promise — because then breaching it has regulatory consequences, not merely contractual ones.
How to do due diligence without being a credit analyst
You don't need a risk team to make a reasonable assessment. You need four things:
Verify the license at the source. It isn't enough that they publish a number: look it up yourself in the regulator's public register. Check that the legal name matches exactly, that the license category covers what they'll provide you, and whether there are notes or restrictions.
Understand the corporate structure. Who is the ultimate owner? Is there a group behind it? Where is the entity you're signing with domiciled, which isn't always the one that appears on the website?
Review the age and track record. A recent entity isn't bad for being recent, but it changes the risk profile. What's relevant is whether the team has a track record even if the entity is new.
Ask about the auditor and the administrator. Every serious regulated entity has both. Their names are verifiable.
The regulatory risk almost nobody evaluates
Here's a point that deserves its own attention.
Verifying that a counterparty has a license is the first step. The second, which almost nobody takes, is verifying that the license covers what it's going to provide you.
License categories aren't interchangeable. An entity authorized as an intermediary in the execution of transactions for clients is enabled to execute your orders. That same entity may not be enabled to supply you a wholesale feed for you to execute on your own book — in several jurisdictions that second activity requires a different authorization.
If you contract an activity that your counterparty's license doesn't cover and the regulator catches it, the service interruption is yours too.
How to verify it: ask for the exact license category, look up the licensing criteria published by that regulator, and check that the activity you're going to contract appears among the authorized ones. It's half an hour of work and it's the best-invested half hour of the whole process.
Diversification: when it pays off
The obvious answer to concentration risk is to have more than one relationship. The cost is real: more integrations, more reconciliation, more relationships to maintain, and less volume per counterparty, which worsens your terms at each one.
In practice, diversification starts to pay off when volume is enough that terms don't deteriorate much when split, and when the operation has the capacity to manage two integrations without duplicating the team.
Below that threshold, it's usually more efficient to concentrate on one well-assessed counterparty than to split between two poorly assessed ones.
An intermediate alternative: keep a second relationship integrated but inactive, with the technical work done and the contract signed. The maintenance cost is low and the switching time goes from weeks to hours.
Signs of deterioration worth watching
Counterparty risk isn't static. It's worth staying alert to:
- Changes in commercial terms without a clear explanation
- Sustained deterioration in execution quality or response times
- Delays in withdrawals, even small ones
- High turnover in the senior team
- Changes in corporate structure or domicile
- New notes in the regulator's public register
None proves anything. Several at once are reason to activate your alternative plan — which is why it's worth having before you need it.
Frequently asked questions
Can't a regulated entity go under? Yes, it can. Regulation imposes capital requirements, controls and reporting obligations that reduce the probability and greatly improve the client's position if it happens — above all through fund segregation — but it doesn't eliminate it. Regulated means supervised, not guaranteed.
Are segregated funds always recovered? They're structurally protected because they aren't part of the insolvency estate, and that radically changes the outcome. The process can take time and depends on the quality of the prior reconciliation, which is why it's worth asking how often reconciliation happens.
How much capital should my counterparty have? Regulatory minimums vary a lot by jurisdiction and category, and the minimum isn't a target but a floor. More informative than the figure is whether the entity is comfortably above its requirement and whether it publishes anything about it.
Is it worth asking for financial statements? In institutional relationships of a certain size, yes, and it isn't an odd request. The answer is also informative: a flat refusal without explanation says something.
Related: how to read a liquidity agreement for the clauses that govern these risks, and LP, prime broker and prime of prime to understand where risk concentrates in each structure.
Our verifiable details — entity, license category, authorization date and the direct link to the FSC of Mauritius's public register — are in legal information, together with the license conditions reproduced in full, including the one on segregation of client funds.
