FRM Part II · FRM Exam Part II · Central Clearing
A risk manager argues that moving a bank's OTC derivatives to a CCP eliminates counterparty credit risk. Which response is most accurate?
The claim is wrong. Central clearing replaces bilateral counterparty exposure with exposure to the CCP and, through mutualised resources, to other clearing members. Margin and default fund contributions reduce but do not eliminate the risk, and CCPs concentrate risk in a single institution.
- ACorrect, because the CCP is legally guaranteed by the central bank in all jurisdictions
- BIncorrect, because the bank's bilateral risk is swapped for exposure to the CCP and its clearing members, mitigated by margin and default fund resourcesCorrect
- CCorrect, because novation converts credit exposure into market risk only
- DIncorrect, because CCPs cannot require initial margin from clearing members
Explanation
CCPs concentrate and mutualise risk; exposure to the CCP remains, e.g. through default fund contributions and potential loss allocation. They are not universally central-bank guaranteed, and they do collect initial margin.
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