Market Volatility and Margin

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Market Volatility and Margin

Last week US President Donald Trump announced comprehensive tariffs on a very high proportion of global trade, with a minimum “reciprocal tariff” rate of 10%.

This sparked strong negative reactions across global markets. In these turbulent times clearinghouses maintain market stability by acting as intermediaries between buyers and sellers. Through novation they become the buyer to every seller and the seller to every buyer assuming all counterparty risk.

This means broker-dealers and other clearing participants such as global custodians or specialist clearing firms are exposed only to the clearinghouse rather than multiple bilateral counterparties reducing overall market risk.

Clearing participants must settle margin accounts daily. Based on net positions and margin calculation methodologies they may need to deposit additional funds or receive credits. This daily mark-to-market process ensures the clearinghouse remains protected.

Clearinghouses use various risk models from straightforward to complex frameworks. These models incorporate historical data including insights from past crises and are updated continuously to adjust margin requirements as market volatility evolves.

A lot of rules have changed since the Global Financial Crisis around the management of financial markets infrastructures like clearinghouses, and the events of last week and this week are a real-time stress test of all these uplifts in operating models and enhancements to risk management at both clearinghouse and clearing participant levels.

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How Volatility Impacts Clearinghouses (CCPs)

Market volatility creates significant challenges for clearinghouses, which serve as central counterparties in financial markets. During periods of high volatility, clearinghouses face dramatically increased transaction volumes that test their technological infrastructure and operational capacity. These surges can strain processing systems and potentially lead to delays if not properly managed.

More critically, volatility directly impacts the core risk management function of clearinghouses. As market prices fluctuate rapidly, the value of collateral held against trades can deteriorate quickly, potentially leading to clearinghouses issuing more frequent margin calls to members.

These intraday margin calls create liquidity pressures throughout the financial system as clearing members scramble to meet obligations within compressed timeframes. However, not every clearinghouse issues intraday margin calls so there is intraday risk exposure until the open trades are either settled in a settlement batch or the next margin call is met.

The default risk that clearinghouses manage also intensifies during volatile periods. Members may face sudden financial distress, increasing the probability of defaults. This requires clearinghouses to maintain robust default management protocols and sufficient financial resources in their guarantee funds.

Regulatory scrutiny of clearinghouses intensifies during market stress, with supervisors monitoring their stability closely. To adapt, clearinghouses invest heavily in algorithmic risk models that can quickly adjust to changing volatility regimes, stress testing capabilities that simulate extreme scenarios, and technological infrastructure designed to handle peak volumes.

Key Takeaways

• Market volatility significantly increases transaction volumes for clearinghouses, testing their technological infrastructure and operational risk management

• Rapid market price fluctuations can deteriorate collateral values quickly, forcing clearinghouses with the capability to issue more frequent intraday margin calls that create system-wide liquidity pressures.

• Default risk intensifies during volatile periods, requiring clearinghouses to maintain robust default management protocols just-in-case they face this scenario and ensure there are sufficient resources in the risk waterfall.

• Post-Global Financial Crisis regulatory changes are currently being stress-tested in real-time, as clearinghouses operating at higher levels of volume and manage risk inside their risk appetite, rules and regulations.

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