At CME Group, we’re intently focused on risk management. It is what we have done for over 100 years. We create fair and transparent markets and maintain their integrity though any scenario. As part of our risk management program, margins, or performance bonds, are adjusted frequently across all of our products based on market volatility. When daily price moves become more volatile, we typically raise margins to account for the increased risk. Likewise, when daily price moves become less volatile, margins typically go down because the risk of the position also decreases.
Margins are set as part of the neutral risk management services we provide. They are not a means to move a market one way or another, or to encourage or discourage participation from one kind of market participant or another. Rather, margin is one of many risk management tools that help us assess overall portfolio risk to protect market participants and the market as a whole.
There are two main margin philosophies that clearing houses can have. First, a clearing house could set margins sufficiently high to cover all possible volatility environments. Changes are less frequent, but margins are significantly higher. Second, and the CME Clearing approach, is to ensure that margins are set to cover 99 percent of the potential price moves. Margins then are lower in less volatile periods and higher in more volatile periods. Changes are often made when the volatility environment experiences a sustained change.
Who determines margin, and what goes into setting margin levels?
At CME Group, CME Clearing is responsible for setting margins. In doing so, we consider several factors to compute the gains and losses a portfolio would incur under different market conditions. Then we calculate the worst possible loss a portfolio might reasonably incur in a set time (usually one trading day for futures markets).
CME Clearing determines “initial margin,” which is the margin that market participants must pay when they initiate their position with their clearing firm, as well as “maintenance margin,” the level at which market participants must maintain their margin over time. We mark positions to market twice a day to prevent losses from accumulating over time. We typically change margins after a market closes because we have a full view of the market liquidity of that trading day. We provide at least 24 hours’ notice of margin changes to give market participants time to assess the impact on their position and make arrangements for funding.
In the case of Gold futures, we have made several incremental changes in margin in recent months to adjust to volatility in the marketplace. On the close of business Friday, January 10, 2020, the margin when a position is initiated was $5,500 per contract (initial margin); throughout the life of that trade, $5,000 in maintenance margin would be kept at the clearing house. By the close of business Tuesday, March 24, 2020 the margin when a position is initiated was $7,700, and there will be $7,000 in maintenance margin at the clearing house.
It also is important to mention that the way margins are calculated has to be tailored to the market served. For example, portfolio margins for our listed derivatives are based on the CME Standard Portfolio Analysis of Risk (SPAN). CME SPAN is the industry standard for portfolio margins used by more than 50 other global exchanges, clearing organizations, service bureaus and regulatory agencies.
As an industry-leading clearing provider, our risk management methodologies have to work to protect the markets we serve. Our interest is in providing security for the entire market – no matter which way it moves.
NOTE: We wanted to make the following paper available to our readers as an additional resource: “Silver and the Margin of Safety.”
Matthew Waldis is the Executive Director and Global Head of Market Risk and Methodologies for CME Clearing.