The margin called by clearing houses should reduce this year if volatility remains at relatively subdued levels and clearing providers introduce more responsive margin methodologies, experts have suggested.
Speaking after Cumulus9 published research that found clearing margin remained elevated last year despite volatility falling, Giuseppe Fiocco and Rafik Mrabet, managing directors at the margin technology firm, said central counterparty (CCP) margins were kept high to guard against a return of volatility.
Fiocco said: “This data, particularly for the energy markets, suggest that most of the time the margins set by CCPs do not reflect closely the current volatility environment, rather CCPs kept their margin rates higher last year in anticipation of another volatility cycle."
He added: “As we moved into a lower volatility environment last year, the CCPs effectively had less incentive to reduce margin and were instead comfortable to keep the margin at pre-2023 levels.”
The Cumulus9 research found that margin increased last year in energy, freight, interest rates and foreign exchange despite volatility dropping from 2022, while margin in the metals and equities markets fell in 2023.
Mrabet said: “CCPs may have kept margin high for a reason, in anticipation of stress events, but if volatility stays low, we would expect CCPs to lower margin rates. They can’t keep them that high forever, at some point there will be pressure from clearing members saying why is the margin so high when volatility has been low for a period.”
The Cumulus9 study found that margin breaches (where the margin called is insufficient to cover losses) fell last year to just 18, compared to 106 in 2022, reflecting the higher margin levels in 2023.
Fiocco said: “As we were going through COVID and Ukraine, margins were adapting to volatility increases so there were losses that exceeded the margin so CCPs increased their margins and, as volatility started to come down, there was a period when the profit and loss of the contract was within the margin level so you would expect fewer breaches.”
Mrabet said the migration of the largest clearing houses to new methodologies will help them align more closely their margin calls to volatility.
“A lot of CCPs have been using SPAN, which by construction is not a reactive model until the CCP updates the rates, whereas the new margining systems based on portfolio Value-at-Risk (VAR) are more dynamic and calibrate volatility on a daily basis so they will be reacting immediately rather than waiting for manual interventions.”
CME plans to extend its VAR methodology to include equity derivatives in the first half of this year after moving its energy products in the third quarter 2022.
Mrabet said: “In 2024, excluding any market dynamics, the reactivity of the models will start to change because the newly adopted VAR-based methodologies, such as CME’s SPAN2, are more dynamic and reactive than SPAN-based models.”
Intercontinental Exchange (ICE) is rolling out its own portfolio-based ICE Risk Model 2 (IRM 2), having gone live with equity index futures at ICE Clear US in January 2022 and added US interest rate futures later that year. The first ICE Clear Europe derivatives to switch to the VAR model will be energy futures and options later this year.
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