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FRM Part II · FRM Exam Part II · Central Clearing

A risk officer is concerned that a CCP's loss mutualization design may weaken incentives. Which feature would most directly strengthen the incentive for the CCP to manage its margin models prudently?

Placing a meaningful tranche of the CCP's own capital ahead of surviving members' default fund contributions strengthens incentives, because the CCP then loses its own money before members do. This aligns its margin-setting and risk management with the interests of the members.

  1. AA meaningful tranche of CCP capital placed ahead of surviving members' default fund contributions in the waterfallCorrect
  2. BAllowing unlimited assessments on surviving members before any CCP capital is used
  3. CReducing initial margin and relying more on the default fund
  4. DFunding the default fund exclusively from the largest members

Explanation

Skin in the game placed before mutualized funds means the CCP loses its own money before survivors do, aligning its risk-model decisions with members' interests. Unlimited assessments or lower margin shift risk to members and worsen the moral hazard.

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