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FRM Part II · FRM Exam Part II · Central Clearing

A bank trades interest rate swaps with ten dealers bilaterally. It then moves all trades to a single central counterparty (CCP) that clears the same products. Which effect is the most direct consequence of this move for the bank's counterparty credit exposure?

Moving trades to a CCP replaces many bilateral exposures with one exposure to the CCP and allows multilateral netting of offsetting positions across dealers. It does not remove credit risk, because CCP failure risk remains and is concentrated, and variation margin is still required daily.

  1. AIts exposure to each dealer is replaced by a single exposure to the CCP, and multilateral netting across dealers becomes possibleCorrect
  2. BIts exposure to counterparty default is eliminated entirely because the CCP guarantees performance
  3. CIts exposure increases because a CCP cannot net offsetting trades between different dealers
  4. DIts exposure becomes unrelated to market moves because variation margin is no longer required

Explanation

Novation makes the CCP the counterparty to every clearing member, so bilateral exposures are replaced by one exposure to the CCP, and offsetting positions across former counterparties can be netted. Exposure is not eliminated, since CCP failure risk remains and is concentrated. Variation margin is required in central clearing, not removed.

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