FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond
A CCP clears a portfolio for two clearing members. Before clearing, Member A and Member B each traded bilaterally with three dealers, and bilateral netting sets were separate for each dealer. After clearing, all trades are with the CCP in one netting set per member. Which statement best explains why multilateral netting through a CCP can reduce total exposures in the system?
Multilateral netting lets gains and losses on trades that were previously with different dealers be offset, because all trades face one counterparty, the CCP. This reduces aggregate exposure, although it does not remove market risk, default fund requirements, or guarantee lower margin for every member.
- AExposures across different dealers can be offset against each other, because all trades are with the CCPCorrect
- BThe CCP eliminates all market risk by taking the opposite position
- CThe CCP removes the need for any default fund contribution
- DThe CCP always lowers margin requirements for every member
Explanation
Bilaterally, a gain with one dealer cannot be offset against a loss with another. Once all trades are novated to the CCP, positive and negative values across former counterparties net into one exposure per member. This lowers aggregate exposure, but it does not remove market risk, default fund contributions, or guarantee lower margin for every member.
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