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FRM Part II · FRM Exam Part II · Central Clearing

Under standard practice at a CCP, which statement about initial margin versus the default fund and the defaulter-pays principle is most accurate?

The defaulter's initial margin and its own default fund contribution are consumed before surviving members' contributions. This is the defaulter-pays principle in the default waterfall. Initial margin is specific to each member and is not mutualized, so surviving members only bear losses after the defaulter's resources are exhausted.

  1. AThe default fund is used first, and the defaulter's initial margin is applied only after all surviving members' contributions are exhausted
  2. BInitial margin is mutualized across all members from the start, so a defaulter's margin is pooled with the default fund
  3. CThe defaulter's initial margin and its own default fund contribution are applied before surviving members' default fund contributionsCorrect
  4. DVariation margin paid by the defaulter is returned to it immediately to preserve its liquidity

Explanation

In the default waterfall the defaulter's own resources, meaning its initial margin and its default fund contribution, are used first, which is the defaulter-pays principle. Only then is the CCP's own capital and the surviving members' contributions drawn upon. Initial margin is member-specific, not mutualized.

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