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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Which crisis lesson led to the Dodd-Frank Act's requirement that standardized over-the-counter derivatives be centrally cleared?

The crisis showed that bilateral OTC derivatives, such as AIG's credit default swaps and Lehman's book, created opaque counterparty exposures that spread systemic risk. Central clearing was required for standardized contracts to provide netting, margining, and transparency, though it does not remove market risk.

  1. ABilateral OTC derivatives created opaque counterparty exposures that spread systemic risk, as seen with AIG and LehmanCorrect
  2. BExchange-traded futures had caused most of the losses at Bear Stearns
  3. CCentral clearing was needed to remove all market risk from derivatives positions
  4. DCredit rating agencies had required clearing as a condition for rating mortgage securities

Explanation

Opaque, bilateral exposures, such as AIG's credit default swap positions and Lehman's derivatives book, made counterparty risk hard to assess and amplified contagion. Central counterparties reduce this through multilateral netting, margining, and transparency. Clearing does not eliminate market risk, and it was not a rating agency requirement.

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