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FRM Exam Part II · Central Clearing

CCP Regulation, Capital and Recovery and Resolution

Updated 11 October 2026 · Fact-checked

After the 2008 crisis, G20 leaders required standardised OTC derivatives to be centrally cleared. Basel gives bank exposures to qualifying CCPs low risk weights, while non-qualifying CCPs get higher capital. If a CCP is stressed, recovery tools restore it; if it fails, resolution authorities take control to keep clearing running.

Understand Regulation, Capital and CCP Recovery and Resolution

Before 2008, most OTC derivatives were traded bilaterally. When Lehman failed, nobody knew who was exposed to whom. In 2009 the G20 agreed that standardised OTC derivatives should be traded on exchanges or platforms where appropriate, reported to trade repositories, and centrally cleared. Non-centrally cleared trades should face higher capital and, later, mandatory margin.

The mandate was written into law in different places. In the US, the Dodd-Frank Act (Title VII) set up clearing requirements, swap execution facilities and reporting. In the EU, EMIR set the clearing obligation, reporting and risk mitigation for uncleared trades. Regulators decide which products must be cleared, based on standardisation, liquidity and the ability of CCPs to manage the risk.

CCPs now concentrate risk, so they are held to global standards. The CPMI-IOSCO Principles for Financial Market Infrastructures (PFMI) cover governance, credit risk, margin, default waterfall, liquidity risk, settlement and recovery. They require, for example, that a CCP covers its exposure to each participant with a high degree of confidence, and that a CCP in a complex market holds enough prefunded resources to cover the default of the two participants (with their affiliates) causing the largest exposure in extreme but plausible conditions (the 'Cover 2' standard). Simpler CCPs must at least meet Cover 1.

Basel capital rules treat bank exposures to CCPs separately. A qualifying CCP (QCCP) is one that is licensed and subject to ongoing supervision and complies with PFMI. For a QCCP, trade exposures get a very low risk weight. Clearing members apply 2% to their trade exposures to the QCCP. A client's exposure, cleared through a clearing member, also gets 2% if the Basel conditions that protect the client's positions if the clearing member defaults or becomes insolvent are met. If those conditions are not met, the client exposure gets 4%. Default fund contributions to a QCCP get a risk-sensitive capital charge based on the CCP's hypothetical capital and the default fund size. For a non-qualifying CCP, trade exposures get the standardised-approach risk weight for a counterparty, while funded default fund contributions are risk-weighted at 1250%, so capital is much higher. The 1250% rule applies to funded contributions. Segregated initial margin carries no counterparty capital charge only if it is bankruptcy-remote from the insolvency of the custodian, the CCP or the clearing member. If it is not bankruptcy-remote, it is exposed to a counterparty risk weight.

CCP recovery means the CCP uses its own rules to cover losses beyond the waterfall and restore a matched book: cash calls, variation margin gains haircutting, partial tear-up of contracts, and compulsory allocation of positions via auctions. Resolution is action by a public authority when recovery fails or is not viable. The FSB Key Attributes and guidance say the authority should maintain critical clearing functions, and can use tools such as transfer of positions, bridge institutions, write-down, and tear-up. The aim is to avoid taxpayer losses and keep markets operating. Loss allocation rules should be transparent so participants can quantify their exposure.

Key formulas to remember

Cover standard (PFMI)
Systemically important CCP: prefunded resources ≥ loss from default of the 2 largest participants (with affiliates) in extreme but plausible conditions
Cover 1 is the minimum for less complex CCPs. Check which one the question asks about.
Default waterfall order
Typical order: Defaulter's initial margin → defaulter's default fund contribution → CCP's own capital (skin in the game) → non-defaulters' default fund contributions → further recovery tools
This is a typical waterfall, and CCP rules vary. For example, some CCPs add a second tranche of their own capital after the non-defaulters' contributions. Order of the waterfall is a common MCQ. Defaulter pays first.
Trade exposure risk weight (QCCP)
Risk weight = 2% on a clearing member's trade exposure to a QCCP. A client exposure also gets 2% if the Basel client-protection conditions are met, and 4% if they are not.
Non-QCCP: trade exposure gets the standardised counterparty risk weight, while funded default fund contributions to a non-QCCP are risk-weighted at 1250%. The 1250% rule applies to funded contributions.
Exposure at default for trade exposure
RWA = RW × EAD, with EAD for QCCP trade exposure = counterparty credit risk exposure measured under the Basel standardised approach (SA-CCR), including margin where permitted
Capital = RWA × minimum capital ratio. The 8% ratio used in simple questions is only a simplifying assumption, so use the ratio the question gives.

How to solve Regulation, Capital and CCP Recovery and Resolution questions

Use this method for any question on clearing rules, CCP capital or recovery and resolution.

  1. 1Identify what is asked: mandate (who and what must clear), capital treatment, or recovery versus resolution.
  2. 2Decide whether the CCP is qualifying (QCCP) or not. If the question is silent, check for PFMI compliance and supervision.
  3. 3For mandate questions, match the law: Dodd-Frank for the US, EMIR for the EU. Remember reporting, clearing and margin for uncleared trades.
  4. 4For capital questions, separate trade exposure from default fund exposure and from posted margin. Apply the correct risk weight to each.
  5. 5For loss questions, run the waterfall in order and stop when the loss is covered.
  6. 6For recovery versus resolution, ask who acts: the CCP under its rules (recovery) or a public authority (resolution).
  7. 7Check units and conditions, then pick the option that matches all stated facts, not only part of them.

Quickest way: Waterfall and Risk Weight Shortcut

When to use it: Use for numerical MCQs on loss allocation or capital on CCP exposures when time is short.

  1. Write the waterfall layers in order with their amounts in one line.
  2. Subtract each layer from the loss until it reaches zero.
  3. For capital, compute EAD × risk weight, then × capital ratio.
  4. Eliminate options that put non-defaulters' resources before the defaulter's own margin and default fund.

Common mistakes in Regulation, Capital and CCP Recovery and Resolution

  • Putting non-defaulting members' default fund before the defaulter's own default fund contribution

    Students remember 'mutualisation' and forget it starts after defaulter resources are used.

    Fix: Defaulter-pays first: its margin, then its contribution, then CCP capital, then others' contributions.

  • Treating all CCPs as qualifying for the low risk weight

    Candidates assume any clearing house is safe.

    Fix: The low weight applies only to QCCPs. Non-qualifying CCPs are treated under the standardised approach.

  • Confusing recovery with resolution

    Both deal with CCP stress and the words sound alike.

    Fix: Recovery is led by the CCP under its rulebook. Resolution is led by a public authority with legal powers.

  • Mixing Dodd-Frank and EMIR provisions

    Both mandate clearing, reporting and margin.

    Fix: Link Dodd-Frank to US swap rules and EMIR to EU rules. Do not attribute one's specific features to the other.

  • Applying capital to segregated initial margin posted by the bank

    Students assume all posted collateral is exposure.

    Fix: Initial margin that is bankruptcy-remote and segregated carries no counterparty capital charge for the poster.

Worked examples

Example 1

A CCP member defaults. Closing out the defaulter's portfolio produces losses of $900 million, before applying any resources. The defaulter's initial margin is $500 million and its default fund contribution is $100 million. The CCP's own skin in the game is $50 million. Other members' default fund contributions total $1,000 million. Using a typical waterfall, how much of the other members' default fund is used?

Show the solution
  1. Loss = $900 million, before applying any resources.
  2. Defaulter's initial margin covers $500 million, leaving $400 million.
  3. Defaulter's default fund contribution covers $100 million, leaving $300 million.
  4. CCP's own capital covers $50 million, leaving $250 million.
  5. Remaining $250 million is taken from the non-defaulters' default fund contributions.

Answer: $250 million of the other members' default fund is used.

Example 2

A bank has a trade exposure (EAD) of €200 million to a qualifying CCP and applies the 2% risk weight. The minimum capital ratio is 8%. What is the capital required for this trade exposure?

Show the solution
  1. RWA = 200 million × 2% = €4 million.
  2. Capital = 8% × €4 million = €0.32 million.

Answer: €320,000 (€0.32 million).

Exam tips

  • Memorise the waterfall order and test it with a quick numeric loss.
  • Know that QCCP status depends on PFMI compliance and supervision.
  • Distinguish recovery tools (cash calls, variation margin gains haircutting, tear-up) from resolution powers of an authority.
  • Read whether the question asks for Cover 1 or Cover 2.
  • Watch for trade exposure versus default fund wording when applying capital.

Practice questions from Central Clearing

Regulation, Capital and CCP Recovery and Resolution: frequently asked questions

What is the clearing mandate under Dodd-Frank and EMIR?

Both require eligible standardised OTC derivatives to be cleared through a CCP and reported to trade repositories. Dodd-Frank applies in the US and EMIR in the EU. Uncleared trades face stricter margin and capital.

What is a qualifying CCP in Basel rules?

A QCCP is licensed, supervised on an ongoing basis and compliant with the CPMI-IOSCO PFMI. Bank exposures to it receive a low risk weight on trade exposures and a specific charge for default fund contributions. For a non-qualifying CCP, funded default fund contributions are risk-weighted at 1250%.

What is the difference between CCP recovery and resolution?

Recovery uses tools in the CCP's own rules to restore a viable matched book, such as cash calls or tear-up. Resolution is taken by a public authority when recovery fails, to keep critical clearing services running.

What does the CPMI-IOSCO PFMI say about CCP resources?

A CCP should hold enough prefunded financial resources to cover its exposure to each participant with a high degree of confidence. Systemically important CCPs in complex markets should cover the default of the two largest participants and their affiliates in extreme but plausible conditions.