At a panel on margin-related issues at the International Derivatives Expo, experts agreed that cleared derivatives market participants would all benefit from greater transparency in clearinghouse margin models.
The discussion centered around market volatility in March 2020 during the early days of the pandemic as well as more recent disruptions in 2022 because of the war in Ukraine. Both periods of volatility triggered sharp increases in margin requirements for exchange-traded futures and options and huge demands for collateral to meet the margin calls.
Dmitrij Senko, chief risk officer at Eurex, noted that the two situations were different insofar as the 2020 challenges were primarily driven by equity markets but the 2022 volatility has been largely focused on commodity markets.
While acknowledging the disruptions were “quite different,” he noted that “the bottom line is that we confirmed markets are unpredictable.”
“It’s not in our business model to predict markets,” he continued “However, there is clearly some appetite to make more predictability in margin.”
Pressures on clearing firms and clients
Gaspard Bonin, deputy global head of derivatives execution and clearing at BNP Paribas, noted that some commodity market volatility even predated Russia’s invasion of Ukraine and that volatility in commodity markets really began in late September 2021.
“If we look at margin on European power and gas contracts, it moved from 15 to 20% of notional in late September to 50% of notional on gas and 80% on power. So margin levels for similar positions for end users has been multiplied by five or six,” Bonin said.
That created significant concerns both in regards to core risk management at BNP Paribas, but also in “helping our clients through this period” to mitigate liquidity risks, he said.
“The amount of intraday financing we’ve been giving our clients has been multiplied by 10 compared with September and today,” said Bonin.
Dale Nolan, chief risk officer of ICE Clear Europe, noted that it’s hard to plan for “idiosyncratic” market events like the volatility seen in European energy markets.
“You’re not going to have a way to completely mitigate the impacts of procyclicality with events like these,” Nolan said. “Making sure the market participants are prepared is key, in particular understanding the impact of that margin on liquidity needs.”
Transparency in margin models
Understanding these impacts can be difficult when there is opacity around how some CCPs calculate initial margin requirements, said Vicky Hsu, head of EMEA counterparty credit risk at BlackRock.
“We have strong risk management processes that are designed to prevent liquidity risks, and our programs are custom tailored to reflect our many different clients with different risk appetites,” she said. “But on IM [initial margin], there’s not much transparency to the buyside how that’s calibrated. The CCP is the calculating agent there, and disclosure is really uneven and varies by the CCP. Having more transparency could help the buyside prepare for this exogenous risk.”
FIA authored a whitepaper in 2020 about the impact of pandemic-related volatility on margin requirements, and has more recently submitted comments on the issue including a letter to the European Securities and Markets Authority in March supporting increased transparency as a key element in preventing procyclical disruptions in derivatives markets.
Barry King, head of financial markets infrastructure regulation at the Bank of England, admitted that when it comes to margin volatility “there’s a limit to what CCPs can do while achieving the right balance between protections and the cost of clearing.” However, CCPs can indeed help when it comes to the preparedness of clearing members and their clients by providing more information about their margin calculation process.
“We need to make sure there’s enough transparency to ensure market participants can prepare for margin calls,” King said.
King also mentioned that the Bank of England is eager for the industry to delve into the consultation on margin that was recently opened to the industry, as part of an effort led by the Basel Committee on Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI), and the International Organization of Securities Commissions (IOSCO). FIA responded to that consultation in January, urging balance in its recommendation.
Dale Nolan of ICE Clear Europe noted agreed with this approach of, noting that margin transparency is important because “there’s a balance of decisions” across areas and better information will lead to better decisions. He also noted that “incorporating regulatory and industry feedback is important” to strike that right balance.
However, Nolan stressed that “cleared and listed derivatives markets have worked well” despite the question of efficiency and predictability when it comes to margin, and the challenge is simply to make markets even more robust and competitive.
“We don’t want to incentivize people to go unhedged or to move people to OTC markets and have another 2008,” Nolan said. “We can safeguard the systemic risk in the industry to prevent contagion, but we also need to make sure we’re charging low enough margins so listed derivatives markets will be competitive and people will stay in those markets.”
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