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FRM Part II · FRM Exam Part II · Central Clearing

Which statement best describes a key difference between a bilateral OTC derivatives relationship under a CSA and a centrally cleared relationship through a CCP?

Under central clearing, novation makes the CCP the buyer to every seller and seller to every buyer, so members face the CCP. In a bilateral CSA the two original parties still face each other, with exposure reduced only by collateral.

  1. AIn central clearing the CCP becomes the counterparty to each side through novation, whereas under a bilateral CSA the original counterparties retain exposure to each otherCorrect
  2. BIn bilateral trading the counterparties novate trades to a third party, whereas in central clearing they keep exposure to each other
  3. CBoth structures eliminate counterparty risk entirely because collateral is exchanged
  4. DCentral clearing removes the need for margin because the CCP guarantees performance

Explanation

Novation replaces the original contract with two contracts facing the CCP, which stands between buyer and seller. Bilateral CSA trades leave direct exposure, only mitigated by collateral. The CCP still requires initial and variation margin and a default fund.

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