Challenges associated with recent developments The benefits from the development of new instruments and markets that I have described will be fully realized only if market participants address various risk-management challenges posed by the use of these instruments. I will discuss three challenges: limiting counterparty credit risk, modeling default correlation, and improving the infrastructure for clearing and settling credit derivative trades.
As in the spot foreign exchange markets, brokers are used to locate counterparties for these trades. They do not act as principal. Once counterparties who are willing to transact at the quoted price have been identified, brokers reveal their names so that they can determine if each other’s credit quality is acceptable and if the exposure can be accommodated within credit limits.