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FRM Part II · FRM Exam Part II · Central Clearing

Under bilateral clearing of OTC derivatives, a bank agrees a credit support annex (CSA) requiring daily exchange of variation margin, with a margin period of risk after the last margin call. What residual risk remains even with daily collateral exchange?

Residual risk remains from portfolio value changes between the last successful margin exchange and the close-out of positions after default, the margin period of risk. Thresholds and minimum transfer amounts can add further uncollateralised exposure, so daily variation margin reduces but does not eliminate counterparty risk.

  1. APrice movements in the portfolio value between the last margin exchange and close-out following a defaultCorrect
  2. BNo residual risk because collateral always equals exposure exactly
  3. COnly the risk that the collateral is returned too early
  4. DRisk that netting is applied to too many trades

Explanation

Even with daily margining, a defaulting counterparty stops posting, and the portfolio can move during the margin period of risk while positions are closed out and replaced. Thresholds and minimum transfer amounts add further gaps. Collateral therefore does not eliminate exposure.

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