By Jo Burnham, Risk and Margin Expert, OpenGamma
As the world continues to battle with the geopolitical aftermath of the Russia-Ukraine war that erupted two years ago, tensions in the Middle East following the Hamas attack on Israel and record-breaking weather events, the global energy and commodity trading landscape finds itself rubbing up against some familiar problems, specifically in the realm of margin management across derivatives markets.
This month’s joint report by the Basel Committee on Banking Supervision (BCBS) and the Committee on Payments and Market Infrastructures (CPMI) underscores the urgency of margin optimisation and forecasting in reshaping risk management strategies for commodities markets. However, it appears that the proposed solutions do not uniformly apply across asset classes, leaving many energy and commodity trading firms still struggling to adapt.
The commodities volatility of 2022, driven by Russia's invasion of Ukraine, serves as a major catalyst for the report's focus. Notably, the European energy markets heavily reliant on Russian oil and gas, have experienced unprecedented spikes in initial margin requirements over the past two years. Despite the glaring challenges, market participants have been slow to devise effective solutions, and the margin analytics landscape remains largely neglected.
The heart of the issue lies in the failure of commodity trading firms to address the substantial increases in margin across derivatives markets since the outbreak of the conflict. In response to soaring energy prices and disruptions in supply chains, many firms have been forced to seek new sources of financing or trying to reduce their positions to meet the escalating collateral requirements. The stark reality is that the events of 2022 have failed to instigate a significant shift in focus towards margin analytics, regardless of whether firms opt for bilateral or cleared derivatives.
The war's onset unleashed unprecedented volatility across all market sectors, with the energy market taking the hardest hit due to its dependence on Russian oil and gas. As prices for essential commodities like Brent Crude and natural gas reached all-time highs, the ripple effect was felt globally. The surge in prices exacerbated inflation, which was already on the rise post-COVID-19 recovery.
The impact on margin was nothing short of significant. For instance, on the Intercontinental Exchange (ICE), the margin rate for Brent Crude experienced a sharp increase in tandem with rising underlying prices. Even with a comparatively favourable initial rate during the pre-war period, the continuous volatility led to observed breaches, prompting ICE to raise parameters further. The CME margin rate witnessed an even higher surge, reaching $12,500 (£9,850) per lot.
Similar patterns emerged in the Natural Gas markets, with prices tripling within a month and margin rates on platforms like EEX/ECC and ICE experiencing substantial increases. While the absolute rise in margin rates was substantial, they represented a reduction in relative terms, highlighting the complexity of the challenge at hand.
Addressing this margin crisis requires a departure from traditional approaches. Only through the deployment of more sophisticated strategies, such as streamlining collateral use, managing net exposures, and embracing risk-based margining, can financial institutions align with the BCBS and CPMI's vision for a consistent and effective approach across global markets.
In an era of heightened investor scrutiny, proactive margin forecasting and optimisation becomes imperative. Beyond fortifying resilience, it aligns with the increasing need for energy and commodity trading firms to strike a delicate balance between risk mitigation and capital efficiency. As the industry grapples with the ongoing geopolitical challenges, the call for a comprehensive and adaptive approach to margin management grows louder. It is time for market participants to embrace innovative strategies, leaning on technology and analytics to navigate the storm and usher in a new era of resilience in commodity trading.
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