October 30th, 2019, 11:39 pm
Collateral exchange and central clearing are fairly effective modern mechanisms designed to reduce losses due to the failure of a counterparty. It is interesting that you did not mention them.
If your failed counterparty provided a hedge you will have to replace it with another trade from another counterparty. If the original trade was collateralized, your losses will be limited to any positive P&L that has moved your way since your last collateral exchange (typically one business day), plus any amount your position might run away from you during the time it takes to find a replacement trade with another counterparty (often termed the “cure period”).
If your trade with a failed counterparty is not collateralized and/or centrally cleared, well, there’s always the courts!