Margins are central to manage counterparty risks, but can create liquidity risks
News, Staff memo Margin is a key tool for managing counterparty risk in transactions involving derivative contracts. The use of margins and clearing at central counterparties (CCPs) are important keys to reducing contagion risks among derivatives market participants. However, in times of market stress, the use of margins can be a source of liquidity risk. It is therefore important to understand what margins are aimed at, and which factors CCPs take into account when calculating the amount of margin to require from market participants.
Following the global financial crisis, requirements were introduced for several types of derivative contracts to be cleared at CCPs to strengthen the financial system. This has led to an increase in the systemic importance of CCPs and the use of margins to manage counterparty risk in derivatives transactions. CCPs require margins from market participants to manage their counterparty risks. However, this comes at the cost of increased liquidity risks for market participants. Not least because CCPs may need to collect large amounts of margins in the form of cash and non-cash collateral during market stress.
In a new Staff Memo, the author Andreas Blanck of the Financial Stability Department, outlines the purpose of margins as well as the factors CCPs take into account when calculating the amount of margins to be required from market participants. Understanding and being transparent about how this is done is key to ensuring robust liquidity planning by market participants, as episodes of market stress in recent years have shown. To this end, global standard-setting bodies have recently made recommendations and proposals for policy action at global level. The background to the recommendations and proposals is that the calculations can be made more transparent, but also that the liquidity preparedness of market participants can be strengthened.
Author: Andreas Blanck, working at the Financial Stability Department.
Staff Memo
A Staff Memo provides members of the Riksbank’s staff with the opportunity to publish advanced analyses of relevant issues. It is a publication for civil servants that is free of policy conclusions and individual standpoints on current policy issues. Publication is approved by the appropriate Head of Department. The opinions expressed in Staff Memos are those of the authors and should not be regarded as the Riksbank’s standpoint.