Home / Offering Memorandum / RISK FACTORS AND INVESTMENT CONSIDERATIONS / Counterparty Risk

18.97. Counterparty Risk

The Investment Compartment will be subject to credit risk with respect to the counterparties to the derivative contracts purchased by the Investment Compartment. Because derivative transactions in which the Investment Compartment may engage may involve instruments that are not traded on an exchange or cleared through a central counterparty but are instead traded between counterparties based on contractual relationships, the Investment Compartment is subject to the risk that a counterparty will not perform its obligations under the related contracts. If a counterparty becomes bankrupt or otherwise fails to perform its obligations due to financial difficulties, the Investment Compartment may experience significant delays in obtaining any recovery in bankruptcy or other reorganization proceedings. The Investment Compartment may obtain only a limited recovery, or may obtain no recovery, in such circumstances. Although the Investment Compartment intends to enter into transactions only with counterparties that the Manager believes to be creditworthy, there can be no assurance that, as a result, a counterparty will not default and that the Investment Compartment will not sustain a loss on a transaction. In the event of the counterparty’s bankruptcy or insolvency, the Investment Compartment’s collateral may be subject to the conflicting claims of the counterparty’s creditors, and the Investment Compartment may be exposed to the risk of a court treating the Investment Compartment as a general unsecured creditor of the counterparty, rather than as the owner of the collateral.

The counterparty risk for cleared derivatives is generally lower than for uncleared OTC derivative transactions since generally a clearing organization becomes substituted for each counterparty to a cleared derivative contract and, in effect, guarantees the parties’ performance under the contract as each party to a trade looks only to the clearing organization for performance of financial obligations under the derivative contract. However, there can be no assurance that a clearing organization, or its members, will satisfy its obligations to the Investment Compartment, or that the Investment Compartment would be able to recover the full amount of assets deposited on its behalf with the clearing organization in the event of the default by the clearing organization or the Investment Compartment’s clearing broker. In addition, cleared derivative transactions benefit from daily marking-to-market and settlement, and segregation and minimum capital requirements applicable to intermediaries. Uncleared OTC derivative transactions generally do not benefit from such protections. This exposes the Investment Compartment to the risk that a counterparty will not settle a transaction in accordance with its terms and conditions because of a dispute over the terms of the contract (whether or not bona fide) or because of a credit or liquidity problem, thus causing the Investment Compartment to suffer a loss. Such “counterparty risk” is accentuated for contracts with longer maturities where events may intervene to prevent settlement, or where the Investment Compartment has concentrated its transactions with a single or small group of counterparties.

In addition, the Investment Compartment is subject to the risk that issuers of the instruments in which it invests and trades may default on their obligations under those instruments, and that certain events may occur that have an immediate and significant adverse effect on the value of those instruments. There can be no assurance that an issuer of an instrument in which the Investment Compartment invests will not default, or that an event that has an immediate and significant adverse effect on the value of an instrument will not occur, and that the Investment Compartment will not sustain a loss on a transaction as a result.