FRM Part II · FRM Exam Part II · Derivatives
A CCP's default waterfall is being reviewed. A clearing member defaults, and its initial margin and default fund contribution are insufficient to cover the losses. Which sequence best reflects the typical order in which resources are used?
The usual order is the defaulter's initial margin, then the defaulter's default fund contribution, then the CCP's own capital, and only after that the surviving members' default fund contributions. Defaulter-pays resources come first, so losses are mutualized last.
- ADefaulter's initial margin, defaulter's default fund contribution, CCP's own capital (skin in the game), surviving members' default fund contributionsCorrect
- BSurviving members' default fund contributions, defaulter's initial margin, CCP's own capital, defaulter's default fund contribution
- CCCP's own capital, surviving members' default fund contributions, defaulter's initial margin, defaulter's default fund contribution
- DDefaulter's default fund contribution, surviving members' default fund contributions, defaulter's initial margin, CCP's own capital
Explanation
The defaulter pays first: its initial margin, then its own default fund contribution. Next the CCP's dedicated capital is used, and only then are non-defaulting members' contributions mutualized. This ordering aligns incentives for the CCP to set margins prudently.
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