The global pandemic gave the derivatives markets their first major test since the implementation of financial reforms that followed the 2008 financial crisis. Central counterparties in particular came under heavy pressure as markets tumbled and transaction volumes rocketed, but they held up well despite the stress, according to the heads of two leading European CCPs.
Speaking on an IDX-V panel moderated by FIA's Jackie Mesa entitled "Volatility and the Pandemic: Did Systems Work?", Daniel Maguire, CEO of LCH Group and group director, post trade division at London Stock Exchange Group, said his firm had to deal with “stress across all markets, all at the same time.” Maguire said that while he was not doing any "victory laps" just yet given the still-volatile environment, the industry should be proud of how it responded.
"This is the first time since 2008 and the reforms that followed where we've had this level of volatility, and it was sustained volatility across almost all asset classes," he said. "The investment that we've made on scalability, resiliency, efficiency of process has paid dividends…we didn't skip a beat."
Hester Serafini, the recently appointed president of ICE Clear Europe, noted the pressure on clearing systems as CCPs dealt with record volumes of exchange-cleared derivatives and exceptionally large margin calls.
"It was relentless in many ways. It was day after day after day; there was no break. There were large moves, record volumes, a large number of intraday calls, there was no time to rest in between because it was never ending. It's a real tribute to the industry as a whole and how we've set things up that we were able to navigate through this period so well," Serafini said, adding that "every call was matched; every call was on time."
During the discussion Mesa pointed to a recent FIA industry sentiment survey showing that three quarters of the respondents said margin volatility and unpredictability was one of the biggest challenges they faced during the pandemic.
Serafini agreed that “there has been a lot of noise in the market about how much money was called for" by clearinghouses during the crisis, but she said most of the increase in margin amounts at ICE Clear Europe came from variation margin rather than initial margin. Variation margin is collected and paid out by clearinghouses as positions are marked to market. As an example, she said on 9 March, when oil prices dropped, ICE Clear Europe called $10 billion in variation margin, compared to $2 billion in initial margin.
Serafini gave cautious support to the idea of establishing "volatility floors" at clearing houses to encourage “more margin stability over time.” This mechanism would limit the decrease in initial margin requirements when markets are quiet to reduce the increase when volatility spikes. She cautioned, however, that any such moves would have to be a globally applied policy.
“We are supportive of having a volatility floor and higher margins in peace time, but it is important that it is applied consistently across different jurisdictions and regulatory regimes [to avoid arbitrage]," she said.
Maguire agreed, adding, "We have implemented floors. I know other CCPs have done the same, you have to have floors so that in normal times it doesn't go too low."
Serafini also warned against calls for a more prescriptive approach when it comes to clearinghouses’ methodologies for calculating and collecting margin.
“I know there is a desire by clearing members to try to make this entirely formulaic and predictable, but I think it is very dangerous to try to get to that. I understand why clearing members want it, but keep in mind that as a member of a clearinghouse you want your clearinghouse to protect itself properly because if it doesn’t do a good job, your money that you've posted in the guarantee fund is at stake. It’s in your interests too that the clearinghouse does its job right,” Serafini said.
She added, "Every crisis is different, every situation is different. The products in the market that are moving are different. The clearinghouse needs to have the flexibility to pull margins based on the situation at hand and if you make it formulaic and you take that flexibility away, it could backfire. I would caution the industry not to be too prescriptive around this sort of thing."
From LCH's perspective, Maguire said margins increased in incremental daily steps to between 18% to 19% but half of that increase was also due to new business.
He added that "anti pro-cyclicality" measures are built into LCH's margin models to prevent a sudden spike in margin calls from destabilizing the market. These measures are designed to address concerns that clearinghouses could force market participants to liquidate positions in order to meet margin calls at the very moment when markets are under the greatest stress.
"Some of this is driven by the requirements we have as a global CCP within EMIR as well as our own standards. We spend a lot of time and intellectual and financial horsepower on ensuring that we have predictable, incremental margin models through all scenarios."
Maguire said LCH calls margin three times a day – which is different from other CCPs – because it clears asset classes globally in multiple currencies. “We think it's prudent to do this three times throughout the day to make sure we capture any losses," he said. “There was no change in our behaviour [during the pandemic]. We think this is a good thing during a crisis,” he added.