CFTC Interim Staff Report in Cleared Derivatives Markets: March - April 2020
This is an interim staff report that provides preliminary analysis and findings related to activity in the cleared derivatives markets regulated by the Commodity Futures Trading Commission1 (CFTC) during March and April of 2020. The goal of this ongoing analytical work is to assess the impact of the COVID-19 shock on multiple parts of the financial system: central counterparties
Cleared derivatives markets are strongly interconnected with other markets, including but not limited to uncleared swaps, securities, physical commodities, loans, etc. Since the cleared derivatives markets operate within the broader financial system, it is difficult to definitively determine the extent of risk transmissions from cleared derivatives markets to the broader system, or vice versa. However, there is broad consensus that the COVID-19 pandemic resulted in a large external shock to these markets as well as the global financial and economic system as a whole.
The scope of this interim report includes CCPs and CMs operating within the CFTC’s jurisdiction, including exchange-traded and cleared futures and options on futures (F&O), cleared interest rate swaps (IRS), and cleared credit default swaps (CDS).
- The almost-complete shut-down of global economic and social activity due to the pandemic was unprecedented, socially and economically, similar in short-term effect
- The shock to economic activity resulted in single day price moves that were more extreme than any move recorded during the past few decades in a number of asset classes.
- Given these extreme (and often historic) market moves, CCPs observed a significantly higher frequency of product-level initial margin (IM) breaches4 across many cleared derivatives products.
- However, analysis of portfolio (not product) breaches shows that both the size and frequency of portfolio-level breaches were well within risk management tolerances. In addition, major CCPs had sufficient pre-funded collateral in the form of IM to cover any potential clearing member defaults. There is also evidence that larger portfolios tend to have more diversified exposures, which potentially helps offset gains and losses both within and across CCPs.
- Initial analysis reveals that changes in aggregate IM flows do not provide conclusive evidence that these models and associated practices were excessively procyclical. Product-level IM change analysis for some key benchmark futures contracts shows that CCPs’ margin models tend to spread the effects of volatility spikes across multiple days. However, CFTC staff continue to study the performance of CCP margin models to address these questions.
- Product-level IM requirement changes are not always correlated with IM changes at an account or portfolio level due to portfolio changes over time. Thus, changes in total account or portfolio-level IM requirements for clearing members, individually or collectively, are not a reliable proxy for measuring the changes in product-level IM requirements. Further, many of the largest CCPs under CFTC’s jurisdiction have in place explicit measures to mitigate margin responses to volatility changes.
- The CFTC regulatory data from this period illustrates rich behavioral heterogeneity across different types of clients (also referred to as participants in the sections below) – e.g. hedge funds, asset managers, insurance companies, pension funds, etc. There is evidence of significant re-positioning of exposures across these different types of market participants during periods of elevated volatility; this re-positioning often can result in large changes in account level IM requirements, independent of other factors.
- The complex nature of these markets makes it difficult to examine causal relationships between margin requirements and trading liquidity in underlying markets. Staff continues to assess if CCP margin calls caused funding or liquidity strains on market participants, though margin calls often represented a small fraction of available liquid resources for larger institutions. Initial analysis indicates that although CCPs allow members and clients to post high-quality non-cash collateral to meet IM obligations, during March 2020 the level of posted cash collateral grew at a cumulative rate of 50%, in line with the growth of other types of commonly collected collateral, like high quality sovereign debt.members and clients to post high-quality non-cash collateral to meet IM obligations, during March 2020 the level of posted cash collateral grew at a cumulative rate of 50%, in line with the growth of other types of commonly collected collateral, like high quality sovereign debt.
- CCP rules typically require clearing members to meet variation margin (VM) obligations with cash. Given the severity of daily price moves and related daily mark-to-market margin calls, VM requirements usually dominated CCP margin flows, often representing levels that were multiples of other sources of collateral demand such as IM calls.
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