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FRM Part II · FRM Exam Part II · Central Clearing

Critics argue that a CCP with a very small skin-in-the-game contribution creates a moral hazard problem. Which statement best explains why?

Small skin in the game weakens the CCP's incentive to be prudent because most default losses are passed to surviving members. The CCP may set lower margin or looser membership standards to win business, which is the moral hazard concern critics raise about the default waterfall.

  1. AThe CCP has little incentive to set prudent margin and membership standards because losses fall mainly on membersCorrect
  2. BThe CCP will refuse to close out the defaulter's portfolio quickly
  3. CThe CCP will collect too much variation margin from members
  4. DThe CCP will be unable to net offsetting positions across members

Explanation

If the CCP's own capital sits only a thin layer ahead of mutualized resources, it bears little of the loss from a default, so it may under-collect margin or accept weak members to gain clearing volume. The other options describe unrelated functions.

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