A Comparative Analysis of Tools to Limit the Procyclicality of Initial Margin Requirements

24 Pages Posted: 30 Apr 2016 Last revised: 13 May 2020

See all articles by David Murphy

David Murphy

London School of Economics - Law Department; Bank of England

Michalis Vasios

European Securities and Markets Authority

Nicholas Vause

Bank of England

Date Written: April 22, 2016

Abstract

The requirement to post initial margin on derivatives transactions is a key feature of the post-crisis reforms of the OTC derivatives markets. Initial margin requirements are usually determined by risk-based models. These models typically require increased margin in stressed conditions: they are procyclical. This procyclicality causes a liquidity burden on market participants which sometimes falls when they are least able to bear it. In this paper we study a variety of tools which have been proposed to mitigate the procyclicality of initial margin requirements. Three of these tools are proposed in European regulation; the other two are new proposals which offer attractive procyclicality mitigation features. The behaviour of all five tools is studied in a simulation framework. We examine the extent to which each tool mitigates procyclicality, and at what cost in demanding unnecessary margin compared to a benchmark unmitigated model. Our findings indicate that all of the tools are useful in mitigating procyclicality to some extent, but that the optimal calibration of each tool in a particular situation depends on the relative weights placed by the modeller on the objectives of minimizing procyclicality on the one hand and minimizing undesirable overmargining in periods of low volatility on the other. This suggests that it may be appropriate to consider moving from tools-based procyclicality regulation to one based on the desired outcomes.

Keywords: Central counterparty, central clearing, initial margin, margin models, OTC derivatives, procyclicality

JEL Classification: G17

Suggested Citation

Murphy, David and Vasios, Michalis and Vause, Nicholas, A Comparative Analysis of Tools to Limit the Procyclicality of Initial Margin Requirements (April 22, 2016). Bank of England Working Paper No. 597, Available at SSRN: https://ssrn.com/abstract=2772569 or http://dx.doi.org/10.2139/ssrn.2772569

David Murphy (Contact Author)

London School of Economics - Law Department

Houghton Street
London WC2A 2AE, WC2A 2AE
United Kingdom

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Michalis Vasios

European Securities and Markets Authority ( email )

103 Rue de Grenelle
Paris, 75007
France

Nicholas Vause

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
143
Abstract Views
675
rank
236,616
PlumX Metrics