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FRM Part I · FRM Exam Part I · Central Clearing

Following a stress period, a CCP raises initial margin requirements sharply as volatility increases, causing clearing members to sell assets to meet calls. Which risk of central clearing does this most directly illustrate, and why is it a concern for regulators?

This illustrates procyclicality. Volatility-driven margin increases during stress force members to raise liquidity, often by selling assets, which can deepen market declines. Regulators respond with anti-procyclical tools such as margin buffers, floors, and through-the-cycle calibration of margin models.

  1. AWrong-way risk eliminated by netting, because margin falls when volatility rises
  2. BProcyclicality, because margin increases in stress amplify liquidity demands and can worsen market declinesCorrect
  3. CBasis risk, because cleared and uncleared prices converge
  4. DNovation risk, because trades revert to the original counterparties

Explanation

Margin models sensitive to recent volatility raise requirements in stress, draining liquidity when members are least able to pay and forcing asset sales, which feeds back into prices. This is procyclicality. Regulators address it via margin buffers, floors and through-the-cycle calibration. The other options do not describe this feedback loop.

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