It is not surprising that following a relentless barrage of margin calls, many have speculated, jokingly or not, that the CME has recently set out on a path of outright warfare with commodities investors and speculators, which was further escalated after the exchange decided to hike WTI margins on a day when priced broadly declined and not in a violent manner either. As the article author herself notes, much to the incredulity of some of her readers: "margins are set as part of the neutral risk management services we provide. They aren’t a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another." The response was in question to when the CME will reduce margins now that the price of silver has tumbled by 30%. We would actually love to get an answer to that as well...
Understanding Margin Changes, from Kim Taylor of the CME
With recent geopolitical events and natural disasters driving volatility in financial markets, margins – good-faith deposits to guarantee performance on open positions – have spent more time than usual under the limelight.
So we thought it might help to provide a very brief primer on margins as part of this conversation.
At CME Group, we’re intently focused on risk management. In over a century, we have not experienced a default. In more than a century, there has never been a failure by a clearing member to meet a performance bond call or its delivery obligations; nor has there been a failure of a clearing member firm resulting in a loss of customer funds. As part of our overall risk management program, margins are adjusted frequently across all of our products based on market volatility. When daily price moves become more volatile, we typically raise margins to account for the increased risk. Likewise, when daily price moves become less volatile, margins typically go down because the risk of the position also decreases.
Margins are set as part of the neutral risk management services we provide. They aren’t a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another. Rather, margin is one of many risk management tools that help us assess overall portfolio risk to protect market participants and the market as a whole.
There are two main margin philosophies that clearing houses can have. First, a clearing house could set margins sufficiently high to cover all possible volatility environments. Changes are less frequent, but margins are higher. Second, and the CME Clearing approach, is to ensure that margins are set to cover 99 percent of the potential price moves. Margins then are lower in less volatile periods and higher in more volatile periods. Changes are often made when the volatility environment experiences a sustained change.
Who determines margin, and what goes into setting margin levels?
At CME Group, CME Clearing is responsible for setting margins. In doing so, we consider several factors to compute the gains and losses a portfolio would incur under different market conditions. Then we calculate the worst possible loss a portfolio might reasonably incur in a set time (usually one trading day for futures markets).
CME Clearing determines “initial margin,” which is the margin that market participants must pay when they initiate their position with their clearing firm, as well as “maintenance margin,” the level at which market participants must maintain their margin over time. We mark positions to market twice a day to prevent losses from accumulating over time. We typically change margins after a market closes because we have a full view of the market liquidity of that trading day. And, we also provide at least 24 hours notice of margin changes to give market participants time to assess the impact on their position and make arrangements for funding.
In the case of silver, we have made several changes in margin in recent weeks to adjust to volatility in the marketplace. By the close of business Thursday, May 5, the margin when a position is initiated will be $18,900; throughout the life of that trade, we would expect $14,000 in maintenance margin would be kept at the clearing house. By the close of business Monday, May 9, the margin when a position is initiated will be $21,600, and we would expect open positions to keep $16,000 in maintenance margin at the clearing house. This is similar to when you sign up for a checking account – a bank will typically require a minimum initial deposit and can then stipulate that you maintain a certain balance going forward.
It also is important to mention that the way margins are calculated has to be tailored to the market served. For example, portfolio margins for our listed derivatives are based on the CME Standard Portfolio Analysis of Risk (SPAN). CME SPAN is the industry standard for portfolio margins used by more than 50 other global exchanges, clearing organizations, service bureaus and regulatory agencies. Margins for credit default swaps and interest rate swaps are quite different because those markets behave differently and have different kinds of variables that produce risk.
As an industry-leading clearing provider, our risk management methodologies have to work to protect the markets we serve. Our interest is in providing security for the entire market – no matter which way it moves.