FRM Part II · FRM Exam Part II · Central Clearing
A risk officer argues that central clearing eliminates counterparty risk for her firm. Which response is most accurate?
Central clearing does not eliminate counterparty risk; it transforms and concentrates it. After novation the firm faces the CCP, and it can still suffer losses through mutualised default fund contributions, assessments, or CCP failure if a major member default exceeds the CCP's resources.
- ACorrect, because novation transfers all credit risk to the regulator
- BIncorrect, because the firm remains exposed to CCP default and to loss mutualisation through default fund contributions and assessmentsCorrect
- CCorrect, because initial margin always covers any loss on a clearing member default
- DIncorrect, because the firm's original bilateral counterparty remains liable after novation
Explanation
Novation replaces bilateral exposure with exposure to the CCP, concentrating risk. Members still face CCP failure risk and potential loss sharing via default fund use and assessments. Initial margin may be insufficient in extreme events, and the original counterparty is released after novation.
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