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FRM Part II · FRM Exam Part II · Margin (Collateral) and Settlement

A dealer faces a counterparty under a bilateral CSA and also clears a similar trade through a central counterparty (CCP). Which feature best describes how a CCP changes the dealer's credit exposure on the cleared trade?

Novation replaces the original bilateral trade with two trades facing the CCP, so the dealer's credit exposure shifts from the original counterparty to the CCP. Risk is concentrated and mutualised rather than removed, and margin requirements still apply to protect the CCP and its members.

  1. AThe dealer's exposure to the original counterparty is replaced by an exposure to the CCP through novationCorrect
  2. BThe dealer's exposure disappears entirely because the CCP guarantees performance without any default risk
  3. CThe dealer keeps the bilateral exposure and the CCP only provides pricing information
  4. DThe dealer's exposure becomes unsecured because margin is no longer required

Explanation

Through novation the original contract is replaced by two contracts, each facing the CCP. Counterparty risk is therefore transferred to the CCP, not eliminated, and margin is still required. The claim that risk disappears ignores CCP default risk.

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