A counterparty is any other party who participates in a financial transaction. Every transaction must have a counterparty for the deal to become completed. Buyers need pairing with sellers, and vice versa.
Counterparties can be individuals, businesses, governments, or any other organization.
Counterparty risk is the risk that the other side of the trade cannot fulfill its obligation under the terms of the transaction and default on the contractual agreement. Counterparty risk can exist in credit, investment, and trading transactions.
In some financial transactions, the counterparty is unknown. In these cases, counterparty risk is managed through clearing firms.
Examples of counterparty risk can include a vendor not providing a good or service after payment. There are also risks that one party will back out of the deal before the transaction completes but after the initial agreement.