FRM Part I · FRM Exam Part I · Central Clearing
Which feature best describes a key weakness of the bilateral OTC clearing model compared with central clearing, as emphasized after the 2007-2009 crisis?
The key weakness is that bilateral OTC trading creates an opaque web of interconnected exposures, where netting works only between each pair of counterparties. This makes contagion more likely when a large dealer fails. Concentrated risk in one entity describes a CCP, not the bilateral model.
- ACounterparty risk is concentrated in one entity, the CCP
- BA web of bilateral exposures creates opacity and contagion, with netting limited to each pair of counterpartiesCorrect
- CStandardized contracts must be used for all trades
- DInitial margin is always mandatory and fixed by an exchange
Explanation
In bilateral markets, netting is only possible within each pair, and exposures are opaque and interconnected, enabling contagion as with Lehman and AIG. Concentration in one entity is a CCP issue, and standardization and fixed margin are not features of bilateral trading.
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