Margin is used by traders to back their derivatives trades but the amount they must post is based on a complex calculation of asset prices and market volatility made by the counterparty, usually a bank or clearing house. The BoE found strong divergence in risk assessment, even in approved models, and raised concerns that traders would face a greater-than-expected calls for margin in volatile conditions.
Although regulators have monitored risk models for decades, its importance has risen as global policy makers mandate that more over-the-counter derivatives trades be processed through privately owned clearing houses. Clearing houses offer differing margin requirements to win business. However, the BoE noted, their risk models are "procylical" – meaning they require more margin for derivatives portfolios times of market stress, which is also the most difficult time for traders to find more stable liquid assets.
The BoE also suggested that banks and authorities runs their own calculations over a period of a few weeks, or using a so-called peak-to-trough ratio, which shows the range of margin requirements over the business cycle.
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BoE Paper: An investigation into the procyclicality of risk-based initial margin models
© Financial Times
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