News: Swap Margins Increase by 12% | CME Group

16 October 2013 | Ben Larah

CME group put an announcement on their website on October 15th stating that, effective October 16th, an Event Risk add-on of  3% will be applied to the base margins for all OTC IRS portfolios.

This will increase by 3% every day over the next four business days, resulting in an eventual 12% Event Risk add-on.

This is apparently a temporary margin increase, which will be rolled back if the uncertainty surrounding the US debt ceiling is resolved.

The original CME announcement is here.

-Ben L.


Hi Bill,CME have outlined their general philosophy with regards to their margin levels in the article below:http://openmarkets.cmegroup.com/3785/understanding-margin-changesOne particular quotation resonates in regard to the events we've been discussing:"When daily price moves become more volatile, we typically raise margins to account for the increased risk. Likewise, when daily price moves become less volatile, margins typically go down because the risk of the position also decreases."

The CME website link suggests that they are anticipating increased probability of "tail events" with these margin increases which I take to mean large upward rate moves as US govt borrowing costs soar in default. Increasing IM implies PFE goes up which makes some sense as future volatility may be higher. I would though have thought that the more pressing problem would be rate volatility driven VM liquidity risk as a CCP struggles to collect larger VM movements from participants with portfolios on the downside of the market move at worst ending in a client or member default.Interesting that all CCPs have not increased haircuts on treasuries like HKEx has which makes some sense to mitigate increased collateral risk. Perhaps they are relying on the bond market price adjustment to handle that for them?

I thought the point of a VaR model with EWMA or GARCH was to respond to short term vol intrinsically as the most recent scenarios have the highest weighting. My understanding of most CCP VaR models is that they need to floor the vol somehow to avoid IM being too low. Eurex have a vol floor I believe to cater for this, so it's interesting that manual intervention is required for CME, rather than a fundamental calibration of their overall model.I suppose their train of thought is that they are adding in anticipated high vol scenarios in advance, rather than wait to see what happens - but again this suggests the vol floor may be too low overall and may not return back from the response to the 12% rise.

Hi Bill,Good question, and something I was pondering myself.Although not related to IR swaps (or derivatives in general), Hong Kong Exchanges & Clearing Ltd. have also raised their collateral requirements in response to the debt-ceiling uncertainty. They have raised their haircuts on short-term treasuries (used as collateral for futures and options) by 2%.Now, back on to the CME 12% add-on. Although Im not 100% certain, it is possible that LCH's look back period of 10y ( to capture Initial Margin (IM) ) captures enough "tail-risk" so that an additional flat add-on isn't necessary to ensure that the CCP is capitalised enough to withstand default. CME's IM calculations use an H-VaR methodology with only a 5y look back period (which is already after the 2008 Lehman crisis). According to CME's website, the 12% figure was decided upon after some scenario analysis. Some extreme scenarios were added to the "generic" (presumably historical) scenarios, with a high probability weighting. Apparently, the resulting margin increase was 12% on average, so a decision was made to apply a 12% margin increase for OTC IR swaps across the board.

Why would this be needed by CME, and why not by any other IRS CCP? Does the 10 year history at SwapClear avoid the need for this? What's your thinking on why this occurred? Bill.

UPDATE: CME have removed the temporary Event Risk add-on measure:"Please be advised that CME Clearing will remove the temporary 3% margin add-on for cleared OTC IRS portfolios. The change is effective as of the October 17, 2013 settlement cycle."The full notice can be found here:http://www.cmegroup.com/tools-information/lookups/advisories/clearing/Ch...