For instruments that trade on an exchange, counterparty risk is substantially reduced.

This is because for exchange traded instruments, such as most stocks and all futures contracts, a essential counterparty or CCP or clearinghouse is involved in every transaction.

Once the terms of a transaction between the seller, party A, and buyer, party B, are agreed that initial contract is canceled and is replaced with two new contracts where the central counterparty or CCP becomes the buyer to party A and becomes the seller to party B.

This is called novation.

This means that if one counterparty to the initial trade defaults, the other party doesn't experience any loss since they won't have a contract with that initial counterparty.

This all but eliminates counterparty risk for the buyer and seller in relation to each other.

What does remain, however, is counterparty risk faced by the central counterparty.

If one party defaults, it is the CCP who would potentially face a loss.

To minimize this counterparty risk, the CCP collects margin from both counterparties.

This will take the form of initial margin payable to the CCP on initiation of a trade to cover the losses it might suffer and variation margin, which is typically paid over to the CCP to cover any losses that are experienced from day to day.

Since the CCP is the counterparty to all trades, a market participant may enter into with an exchange, any offsetting exposure can also be netted off reducing the overall exposure that the CCP faces to any one party.