Futures margin payments

[Benjamin]

Hi,

Just a point of clarification on the maintenance/variation margin payments (in) process:
1. Initial margin is set at establishment of the contact and paid
2. Daily level of outstanding margin adjusted by marking to market movements
3. If outstanding margin reduces enough so that it breaches the maintenance margin level, the contract holder must pay in enough to top up to the initial margin amount

And so, daily payments in by the contract holder are not necessarily made as a payment is only required if enough margin is eroded so as to breach the maintenance level - is that correct?
- Core reading implies that top-ups have to paid daily (CMP, Ch1, p.7 top paragraph)
- ActEd commentary states as above (CMP, Ch1, p.6, top paragraph)

I see the ActEd comment below that core reading reference which reads as brokers pay daily and investors using a broker operate per my description above, however:
- Members can be investors so not all investors are a step removed. In which case if you are member, you would have incentive to invest via another member instead of directly to reduce liquidity demands, which may be worth it to you despite the fee you would incur - does that happen?
- Does this not add credit/liquidity risk at the broker level as they are meeting margins daily while not receiving top up from the investor until the threshold is breached.
- Who sets the maintenance margin level? The clearing house or the broker?


And if correct, a couple of further questions:

- This means that the maintenance margin level is some amount less than the initial margin level - how is this amount calculated? Is it some % of the initial margin (reflecting volatility and credit risk of contract holder)?

- If markets move in your favour and your margin increases, you can withdraw any amount above the initial margin - doesn't this not increase risk to the clearing house on balance? If you can withdraw any amount above the initial margin but only have to pay in if you fall some material amount below the initial margin, then money is being taken out by one party and not completely replaced by the other.

Regards,

Ben

 

[Simon James]

1. Initial margin is set at establishment of the contact and paid. Yes
2. Daily level of outstanding margin adjusted by marking to market movements. Yes
3. If outstanding margin reduces enough so that it breaches the maintenance margin level, the contract holder must pay in enough to top up to the initial margin amount. Yes

- does that happen? Maybe, but the broker would then be speculating on their own account, which probably breaks all sorts of rules!
- Does this not add credit/liquidity risk at the broker level as they are meeting margins daily while not receiving top up from the investor until the threshold is breached. Yes, so the broker needs to ensure the margin taken from the investor covers the margin from the clearing house. As an example of this, google what happened to some brokers when he Swiss peg was removed in 2015
- Who sets the maintenance margin level? The clearing house or the broker? The clearing house is the one we are interested in


And if correct, a couple of further questions:

- This means that the maintenance margin level is some amount less than the initial margin level - how is this amount calculated? . Is it some % of the initial margin (reflecting volatility and credit risk of contract holder)? It varies by market and clearer - the LCH publish their methodology online

- If markets move in your favour and your margin increases, you can withdraw any amount above the initial margin - doesn't this not increase risk to the clearing house on balance? Yes. You could always "withdraw" by closing the contract, taking the profit and buying a new contract at the new initial margin level. If you can withdraw any amount above the initial margin but only have to pay in if you fall some material amount below the initial margin, then money is being taken out by one party and not completely replaced by the other. If prices have moved and one party has gained, the other party has already paid in to cover their loss.

 

[Benjamin]

Hi Simon,

Thanks for the thorough response! I bit of follow up on the last response, it doesn't seem that the other party will always have already paid in as they are only paying in once the maintenance margin is breached. So there's a window there where the losing party hasn't topped up yet but the winning party can withdraw margin in excess of the initial level.

Does that make sense?

 

[Simon James]

But don't forget the losing party will have deposited initial margin. If both parties initially deposit 100, say, and maintenance is set at 70, then the clearer holds 200. If the price changes by 20, position are 120 and 80, total still 200. If price moves by 40, positions are 140 and 60, but the losing party has to deposit a further 40. The winner can take 40 profit, leaving 100, the loser is back to 100, net 200 and the total net cashflows are 100+100+40-40=200.

 

[Benjamin]

Yes but in the first part of the example, the winner can take their 20, leaving them at 100 and loser is at 80 and does not yet need to top up, so the CH is sitting at 180 - that's the scenario I'm wondering about.

Or is it that you can only withdraw if you are above the maintenance margin in the positive?

 

[Simon James]

You can only withdraw above the initial margin.

In the +/-20 case, the winner has 100 (20 withdrawn) and the loser is on 80. The CH has 180 of cash = the total margin accounts of both parties. It's all good!