Explanation:
Central clearing works best for instruments that are standardized, easy to value, liquid enough to support margining, and suitable for multilateral netting. If each contract requires heterogeneous, non-standard legal terms, then the instrument is not homogeneous enough for a CCP to clear efficiently.
The strongest barrier to central clearing is usually lack of standardization, especially in legal terms and contract structure.
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Q-604.1. A central counterparty (CCP) is evaluating a new derivative instrument as a possible candidate for trading on its central clearing platform. The following four features are associated with the candidate derivative instrument. Which of the following is MOST LIKELY to render the instrument incompatible with central clearing?
A
The candidate derivative instrument requires heterogeneous (ie, non-standard) legal terms such that each contract is unique
B
The candidate derivative instrument is simple (ie, not complex) however valuation models are quite sensitive to input assumptions
C
Several of the counterparties, who are interested to trade the candidate derivative instrument, are not currently members of the CCP
D
The candidate derivative instrument has an historical price volatility that is significantly above average, although volume has been deep