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FRM Part II · FRM Exam Part II · Central Clearing

A risk committee notes that moving OTC derivatives to a CCP reduces bilateral counterparty risk. Which risk is most directly increased by this shift, and therefore needs the closest oversight?

The main increased risk is concentration in the CCP, which becomes a single point of failure, together with procyclical margin calls in stress. Clearing improves netting and replaces bilateral exposures, so the other options describe effects that clearing reduces or does not cause.

  1. AConcentration of risk in the CCP, which becomes a single point of failure and a source of procyclical margin callsCorrect
  2. BIncreased uncertainty about who the counterparty is on each trade
  3. CLoss of the ability to net offsetting positions across members
  4. DHigher bilateral credit exposure between clearing members

Explanation

Novation concentrates risk in the CCP, making it systemically important, and margin can rise in stressed markets (procyclicality). Clearing increases rather than reduces netting, and bilateral exposure between members is replaced by exposure to the CCP.

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