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FRM Part II · FRM Exam Part II · Central Clearing

A CCP's recovery plan after a default that exhausts the entire default waterfall includes variation margin gains haircutting (VMGH) and partial tear-up of contracts. A risk manager at a clearing member concludes correctly that which is the key risk of VMGH for the member?

Variation margin gains haircutting means members with gains may receive less than they are owed, so they bear an uncertain, unhedgeable loss in recovery. It is not capped at their default fund contribution, and payment is not guaranteed in full.

  1. AThe member's initial margin is immediately returned, removing its exposure to the CCP
  2. BThe member may receive less than the variation margin gains owed on in-the-money positions, creating an uncertain loss that cannot be hedged by the margin it holdsCorrect
  3. CThe member's liability is capped at its prefunded default fund contribution, so no further loss is possible
  4. DThe member is guaranteed full payment because variation margin is segregated from the CCP

Explanation

In VMGH, the CCP pays members with gains less than the full amount owed to cover the shortfall, so members with in-the-money positions bear loss uncertainty. It is not capped by default fund contributions, and variation margin is not guaranteed full payment; initial margin is not returned.

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