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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

A risk manager at a large dealer bank explains why Dodd-Frank and related rules impose margin requirements on non-centrally-cleared derivatives. Which is the best rationale?

Margin requirements on uncleared derivatives reduce counterparty credit exposure and make bilateral trades more expensive than centrally cleared ones, nudging market participants toward clearing. They do not remove market risk, eliminate capital charges or stabilize prices.

  1. ATo raise the cost of bilateral trades relative to cleared trades, encouraging central clearing, and to reduce counterparty credit riskCorrect
  2. BTo eliminate market risk on derivative positions
  3. CTo allow banks to reduce their capital to zero for such trades
  4. DTo ensure that derivative prices remain constant

Explanation

Margin on uncleared derivatives (initial and variation) lowers counterparty credit exposure and makes bilateral trading costlier than clearing, which incentivizes clearing. It does not remove market risk or eliminate capital needs, nor fix prices.

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