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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

A regulator wants to reduce systemic risk from the OTC market by moving standardized bilateral trades to central counterparties. Which outcome is the LEAST likely consequence of mandatory central clearing?

The least likely consequence is that customized, illiquid trades become fully standardized and free of bilateral credit risk. Clearing applies to standardized contracts, so bespoke trades remain bilateral. Clearing does bring multilateral netting, higher collateral demand and risk concentration in the central counterparty.

  1. AMultilateral netting can reduce the total exposure among dealers
  2. BInitial and variation margin requirements increase demand for high-quality collateral
  3. CCounterparty risk is concentrated in the CCP, making its resilience critical
  4. DCustomized, illiquid trades become fully standardized and no longer bear bilateral credit riskCorrect

Explanation

Mandatory clearing applies to standardized trades; highly customized trades usually remain bilateral and still carry credit risk. The other three outcomes are recognized effects: netting benefits, higher collateral demand, and concentration in the CCP.

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