Margin Requirements for Non-Cleared Derivatives

19 Pages Posted: 11 May 2018 Last revised: 20 May 2018

Date Written: April 25, 2018


The advent of mandatory daily initial and variation margin requirements for non-cleared over-the-counter derivatives transactions has raised many questions regarding the methodology which should be used for computing these margin requirements. Regulatory guidelines require initial margin levels for non-cleared contracts to cover a 99% loss quantile of the netting set over a horizon of 10 days, as opposed to 3 to 5 days for cleared OTC contracts. We discuss the rationale behind this and other features of the proposed framework for bilateral margin requirements and advocate an approach which better reflects the actual exposure during closeout in case of the default of a counter party.

We argue that the liquidation horizon should depend on the size of the position relative to the market depth of the asset. This may be achieved by specifying a minimum liquidation horizon for each asset class, associated with an asset-specific size threshold, and scaling the liquidation horizon linearly with position size beyond this threshold. Adopting such a size-dependent liquidation horizon leads to a liquidity-sensitive initial margin, which penalizes large concentrated positions without requiring any ‘liquidity add-on’.

We also argue that the IM calculation needs to account for the fact that market participants hedge their exposures to the defaulted counter party once default has been confirmed. As a result, IM should not be based on the exposure of initial position over the entire liquidation horizon but on the exposure over the initial period required to set up the hedge, plus the exposure to the hedged position over the remainder of the liquidation horizon.

Based on these remarks, we propose a “four-step approach” for the calculation of IM for over-the-counter derivatives transactions. We argue that this approach yields a more realistic assessment of closeout risk for non-cleared transactions and leads to an outcome which is in general quite different from the risk exposure of the netting set over the liquidation horizon.

Keywords: Collateral, Over-the-Counter (OTC) Derivatives, Central Clearing, Liquidity, Financial Markets, Counter Party Risk, Default Risk, Financial Regulation

JEL Classification: G18, G24, G28

Suggested Citation

Cont, Rama, Margin Requirements for Non-Cleared Derivatives (April 25, 2018). Available at SSRN: or

Rama Cont (Contact Author)

University of Oxford ( email )

Mathematical Institute
Oxford, OX2 6GG
United Kingdom

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