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Audrius Jukonis

29 October 2019
Initial margin (IM) reduces counterparty credit risk in derivative markets. Notwithstanding efforts to limit potential procyclical effects of IM-setting practices, there is an ongoing debate about whether the current framework sufficiently addresses this concern, in particular when Value-at-Risk (VaR) models are used for setting IM. This article provides further insights into this issue. First, using EMIR data, we provide an overview of outstanding IM in the euro area derivative market and identify the most relevant sectors for the exchange of IM. Second, using a VaR IM model in line with industry practice, we show that aggregate IM can potentially vary substantially over a long-term horizon. Finally, we show that an IM floor based on a standardised IM model could be an effective tool for reducing IM procyclicality.
JEL Code
G10 : Financial Economics→General Financial Markets→General
G23 : Financial Economics→Financial Institutions and Services→Non-bank Financial Institutions, Financial Instruments, Institutional Investors
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
26 May 2020
Financial Stability Review Issue 1, 2020
Stricter margining requirements for derivative positions have increased the demand for collateral by market participants in recent years. At the same time, euro area investment funds which use derivatives extensively have been reducing their liquid asset holdings. Using transaction-by-transaction derivatives data, this special feature assesses whether the current levels of funds’ holdings of cash and other highly liquid assets would be adequate to meet funds’ liquidity needs to cover variation margin calls on derivatives during stressed market periods, once the derivative portfolios become fully collateralised. The evidence so far indicates that euro area funds were able to meet the fivefold increase in variation margin during the height of the coronavirus-related market stress. But some of them were likely to have done so by engaging in repo transactions, selling assets and drawing on credit lines, thus amplifying the recent market dynamics.