Explanation:
Moral hazard is the risk that one party will take on higher risk knowing that another party bears the costs of this risk. In central clearing, the risk is that members will have less incentive to monitor risk knowing that the CCP takes on most of the risks.
(Book 3, Module 32.1, LO 32.c)
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Question 97
Counterparty X is in the process of moving from the bilateral over-the-counter (OTC) market to netting through a central counterparty (CCP). This move will help reduce total risk for X as well as minimize the potential of a domino effect stemming from the default of a market participant. Which of the following statements best describes a disadvantage of this approach of using central clearing through a CCP?
A
Members will have less incentive to monitor risk knowing that the CCP takes on most of the risks.
B
A member’s losses cannot be distributed among surviving members, which increases systemic risk.
C
The centralized role of CCPs in the clearing and settlement process reduces operational efficiency while increasing costs.
D
The daily margining of products in a centrally cleared market creates less transparency in product valuation, which reduces product liquidity.
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