In the absence of full collateralisation of the exposure that participants present to the clearing house, the default of one participant could trigger the default of one or more other participants, propagated through the loss allocation mechanism of the clearing house. In addition, it is possible that two or more independent defaults occur simultaneously.

In the bilateral netting environment, the loss to a participant that results from the default of two or more of its counterparties equals the sum of its bilateral exposures to both and the amount of capital set aside to support such losses is proportional to this sum. In the multilateral netting case, however, the loss to a participant as a result of the default of two or more of the other clearing house participants could exceed the sum of the corresponding primary loss allocations.

As an interim solution, the Committee believes that the relatively conservative treatment of potential future exposure described above may provide, at least to some extent, a cushion for the risk of second round defaults. However, more work needs to be carried out in the future to better understand this type of risk, which might have to be addressed separately through an additional capital charge. The Committee invites comment on the nature of second round default risk and on possible methodologies for capturing this risk under the framework of the Accord.