A blog on financial markets and their regulation
Unifying initial and maintenance margins
November 7, 2011Posted by on
The bankruptcy of MF Global prompted CME Clearing to temporarily unify maintenance and initial margins (h/t Kid Dynamite). I would argue for a permanent abolition of the distinction between these two margins.
Initial margin is the margin that market participants must pay when they initiate a position while the maintenance margin is the level at which the margin must be maintained subsequently. I believe that this distinction is quite silly. The whole purpose of daily mark to market is to ensure that every day begins on a clean slate. There is absolutely no difference between a position initiated yesterday and a position initiated today because yesterday’s losses and gains have already been settled in cash. To pretend otherwise is a delusion. CME Clearing stated in its notice that:
Maintenance margins are set to provide appropriate risk management coverage. Initial margins are set to provide an additional buffer against future losses in the account.
In these troubled times, no one can argue against additional buffers, but the idea of applying buffers selectively to some positions is absurd. The situation becomes even more ludicrous when we consider a large portfolio of positions where new positions do not necessarily correspond to new risks.
In the days when fund transfer was slow and painful, it made sense for customers to deposit extra margins to avoid the hassle of managing daily cash inflows and outflows. This is no longer relevant with today’s electronic payment systems. In any case, that should be a matter for the individual customer to decide. There is little merit in the clearing corporation micro-managing the cash management policies of its customers.
CME Clearing is absolutely right in saying that “Maintenance margins are set to provide appropriate risk management coverage.” It should stop with risk management and leave cash management to market forces.
I am quite disturbed by the statement from CME Clearing that “This is a short term accommodation to maintain market integrity and provide temporary relief to customers whose accounts have been disrupted by this event.” One expects risk managers at clearing corporations to be ruthless and uncompromising on protecting the clearing corporation from risks. Words like accommodation and relief should not be part of their vocabulary at all. Instead CME Clearing should have said that since it is illogical for customers to pay a higher margin merely because their positions have been transferred from MF Global to another clearing member, they are permanently unifying their margins.