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Basel strongly recommends Central Counterparties to be used, in order to manage the credit risk in Over The Counter contracts. According to the ISDA’s Variation Margin Gains Haircut (VMGH) mechanism (« CCP Loss Allocation at the End of the Waterfall »), it looks like this credit risk is going to be primarily covered by the Central Counterparty via  (haircuts in) the gains of the Clearing Members  which arise since the default is spotted. As the clearing is done via the Central Counterparty, there is always one of the two participants in the Over The Counter deal that is going to make a gain.

But this so-called Haircut (in the gains) Risk should show up somhow in the pricing of the OTC instrument, given that Over The Counter derivatives pricings are based on potential gains. Haircut risk looks like a type of credit risk, which appears conditional of the market (risk and gains), and might be triggered by and triggers itself liquidity risk, as the taken amount might be returned once the recovery done.  It is interesting how to price it, as it is a idiosyncratic risk (linked to the specific defaulting CM) which can be hedged, by making it market insenistive, with no future gains to show up.  But it turns out to be a hybrid with systemic risk, as it depends a lot on how many counterparties are defaulting, on average, within the Central Counterparty net.

Integrated risk modelling (credit, liquidity and market) becomes more and more necessary.