The risk that a counterparty to a derivative contract may be unable or unwilling to fulfill contractual obligations with respect to making timely payments and settling due payables. This situation may arise from an actual default or by deterioration in a counterparty’s credit quality.

In the event of default, immediate losses would be incurred by the other counterparty, whereas future losses, in the event of deteriorating credit quality, would be expected, with an actual impact being inflicted on mark-to-market valuations.

It is also referred to simply as counterparty risk.