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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

In a centrally cleared derivatives market, a central counterparty (CCP) becomes the legal counterparty to both original trading parties through novation. What is the primary effect of this arrangement on a clearing member that bought a contract from another member?

Through novation the CCP steps between the buyer and seller, so the buying member's credit exposure is to the CCP instead of the original seller. Margin is still required, and exposure is not doubled or netted across all members' positions.

  1. AThe member's exposure is to the CCP rather than to the original sellerCorrect
  2. BThe member no longer needs to post any margin
  3. CThe member's exposure to the original seller is doubled
  4. DThe member's position is netted against every other member's positions in all contracts

Explanation

Novation replaces the original bilateral contract with two contracts, each facing the CCP. The buyer's credit exposure is therefore to the CCP, not the original seller. Margin is still required, so the second option is wrong, and exposure is not doubled.

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