The Impact of Initial Margin

Abstract

Since the global financial crisis, two significant regulatory initiatives have been introduced in the form of the central clearing mandate and bilateral margin requirements. A major implication of these initiatives is the need for major players in the OTC derivative market to post collateral, in the form of initial margin, against their transactions. In this paper, we discuss some of the problems associated with initial posting, such as the quantification of the residual counter party risk and associated capital requirements. We also characterise a wealth transfer mechanism when parties post initial margin which causes OTC derivative creditors to become more senior at the expense of other creditors. Initial margin has clear funding implications in the form of margin value adjustment (MVA) and the pricing of the underlying wealth transfer effect in unsecured lending transactions.

Keywords: Initial margin, collateral, MVA, wealth transfer, SIMM, central counterparty, BCBS-IOSCO

JEL Classification: G1