Coronavirus, Market Volatility and double margin calls…
The current unprecedented volatility has led to significant swings in Mark-To-Markets (MTM) and has led to increased margin calls which have been fulfilled by further selling off assets. The MTM volatility has increased both Variation Margin and Initial Margin. Lack of liquidity, outsized moves and volatility all make the bid-offer wider, complicating risk management for traders.
We have seen evidence of this in the gold sell-off. Gold has traditionally been a risk-off asset, an asset where investors park cash in times of stress. Gold has also suffered the sell-off and the primary reason for this is the increasing margin calls.
Risk-managers keep an eye, in real-time, on the amount of margin needed to post for all underlying positions.
Margin is composed of two main components –
- Variation Margin (VM) – This is the mark-to-market (MTM) on the portfolio and is a direct function of the market moves. This needs to be exchanged daily and in current market conditions, some exchanges and dealers want this covered intra-day as well
- Initial Margin (IM) – This safeguard against future market moves. Unlike VM, which is simply MTM, IM generally relies on calculation of profit-and-loss scenarios and taking a conservative confidence level and the loss associated with it as the margin.
Cassini conducted research on how initial margins have changed from 12th February 2020 to 13th March 2020. We chose these dates to capture a variety of events: The peak of the Dow Jones Index (12th February), the lowest level the Dow Jones so far (12th March 2020), the WHO declaration of Pandemic, Central Bank Actions and the United States declaring the Coronavirus as ‘National Emergency’. (Suffice to say, we are still very much in this situation of high volatility and it will be sometime before we can finally understand when the threat of Coronavirus recedes).
Further, given the different methodologies used to calculate IM, we have tried to capture the differences from the perspective of SPAN (used by most exchanges covering futures & options), VaR (used by CCPs for OTC products) and SIMM (used for most bilateral margining).
A few key observations –
- IM amounts have increased across the board in times of unprecedented market moves
- Given the volatility, some contracts have seen margins almost double!
- The margins under both VaR and SIMM for the same underlier increased but in different proportions, see below
- These are standalone numbers but highlight the fact that increasing margin is clearly something to keep an eye on.
SIMM and volatility
SIMM methodology relies on weights for the risk-factors and these risk factors are adjusted annually in the calibration exercise. The reason the margin increases under SIMM (see table above) is because of changes in the underlying market data changes leading to a change in the sensitivity of the position.
Given the static weights for risk factors, the only reason margin changes is due to market data leading to change in sensitivity. On the other hand, clearing house methodology relies on historical scenarios, taking into account the current volatility to adjust the scenarios. This methodology captures both the change in market data led sensitivity but also the adverse risk scenarios impacting margin.
It is expected, due to the differences in methodology, there will be differences compared to SIMM which is higher compared to the VaR methodology used by exchanges as it is based on a 10-day margin period of risk and is conservative to start with.
The volatility however puts into debate a few things and we will be keenly watching any communication from regulators:
- Calibration – This is generally done throughout the year, but updates only occur towards the end of year. This calls into question where there would be interim calibration and updates to models and risk-factors to account for the on-going volatility
- Back-Testing – Under model governance, SIMM always has to provide a more conservative number than the 99% VaR estimates on portfolios. Given the recent volatility, it is highly likely that there will be cases where firms might see SIMM failing this test. In such cases, counterparties, especially the sell-side, would most likely demand margin according to back-testing numbers rather than SIMM.
Cassini is committed to help our clients. Contact us please if we can offer any guidance around understanding the calculation as well as movement in your margin.