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FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond

A risk manager analyzing the shift of OTC derivatives to central clearing is concerned about procyclicality and concentration. Which of the following is the most accurate concern?

The key concern is that volatility-sensitive initial margin rises in stress, forcing members to find liquidity at bad times, while clearing concentrates risk in a few CCPs that become single points of failure. Clearing does not remove liquidity risk.

  1. AInitial margin models sensitive to recent volatility can raise margin calls in stress, draining liquidity from members, while concentration makes the CCP a single point of failureCorrect
  2. BCentral clearing increases bilateral exposures because trades are no longer netted
  3. CCCP margin requirements fall sharply as volatility rises, creating undercollateralization
  4. DMandatory clearing eliminates liquidity risk for clearing members because variation margin is not required

Explanation

Volatility-responsive margin raises calls precisely in stress, creating liquidity demands and procyclicality; concentration of risk in few CCPs makes them systemically important. Margin rises, not falls, with volatility, and variation margin is still paid daily.

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