Washington, DC—FIA today released a white paper that examines the dramatic increase in margin requirements at derivatives clearinghouses during the first quarter of 2020 due to increased market volatility related to the pandemic.
Although the clearing system performed well during exceptional volatility and trading volume, the increase in margin requirements created a large and sudden demand for liquid assets that contributed to stress in the financial markets. FIA views this episode as an important test of the clearing system and in this paper puts forward several recommendations to improve margin models.
"Our analysis demonstrates that the system worked, but it was strained during the economic crisis created by the Covid-19 shutdown and business cycle downturn. As an industry, we must look at those strains and make the adjustments needed to avoid undue pressure on liquidity," said FIA President and CEO Walt Lukken.
The analysis is based on public data published by the Commodity Futures Trading Commission and 10 major derivatives clearinghouses as well as data provided by FIA clearing members. The key findings include:
FIA’s paper explains that sudden increases in margin requirements create a type of feedback loop called procyclicality. Margin calls drive demand for liquid assets, just when those assets are scarce due to market stresses. This drive for liquid assets can spill over into other financial markets and can contribute to systemic risk.
"March 2020 was a real-life stress test of the system and it provides an opportunity to examine the data and consider where adjustments are needed. Clearing has made the financial system safer, but extreme jumps in initial margin over short periods of time put a lot of stress on clearing members and their customers," said Jacqueline Mesa, FIA’s COO and SVP of Global Policy.
FIA’s paper seeks to promote dialogue on the issue of procyclicality in clearinghouse margin requirements and makes several recommendations for improvements to margin models. FIA calls for:
This paper is part of a continuing effort by FIA to enhance risk management in the clearing system. In 2015, FIA published a global CCP risk position paper and followed that up with a 2018 CCP risk management recommendations. FIA has also issued several reports and white papers on managing the risk of electronic trading.