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FRM Part II · FRM Exam Part II · Central Clearing

Following the global financial crisis, regulators introduced mandatory clearing of standardised OTC derivatives and higher capital for non-cleared trades. Which rationale best supports the capital and margin incentives favoring central clearing?

Central clearing nets exposures and mutualises losses through margin and default funds, reducing bilateral counterparty risk. It does not eliminate risk, since it concentrates risk in the CCP, and market risk stays with the position holders. Margin is still required.

  1. ACentral clearing eliminates all counterparty, liquidity and operational risk
  2. BCentral clearing multilaterally nets exposures and mutualises default losses, reducing bilateral counterparty risk, though it concentrates risk in the CCPCorrect
  3. CCentral clearing removes the need for any margin on cleared trades
  4. DCentral clearing transfers all market risk from clients to the CCP

Explanation

CCPs net exposures across members and apply margin and mutualised default resources, lowering bilateral counterparty risk and contagion. However, risk is concentrated in the CCP, making CCP resilience critical. Risk is not eliminated, margin is required, and market risk remains with the position holders.

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