The Markets ConversatION Podcast

Quick Takes: Best practices for variation margin

April 4, 2024 | Duration: 10 minutes

Speakers: Amir Khwaja and Chris Barnes


In this episode, Chris dives into the world of variation margin, an important topic in the derivatives industry. He discusses the challenges of intraday margin calls and the lack of standardization across CCPs. Amir joins in to discuss the return of funds and they debate the need for clearer practices. Hear their insights and why Chris Barnes hopes this won’t be his last podcast!


Ali Curi: Hi everyone, and welcome to ION Markets Quick Takes. I’m Ali Curi, and every week, along with my guests, Amir Khwaja and Chris Barnes, we take a quick dive into the headlines on the Clarus blog.

Let’s get started. Hi Amir. Hi Chris.

Amir Khwaja: Hi Ali.

Chris Barnes: Hey Ali, how you doing?

Ali Curi: I’m doing great. It’s great to see you all again.
Chris, let’s start with you. What’s your Quick Take for this week? Which headline from the Clarus FT blog would you like to discuss?

Chris Barnes: All right, Ali, I’m going to cover a blog that I wrote a surprisingly long time ago now. It’s called “Best Practices for Variation Margin.” And whilst the podcast normally it’s written about a blog that’s fairly fresh, this one I actually had to go back and make some notes on.

And I have made my first note at the very top of my page saying, “Is this my latest attempt to try and kill my fledgling podcasting career?” Because whilst I’m pretty sure nobody’s ever podcasted about SACCR or about cross currency swaps, I’m pretty sure also nobody would ever choose to talk about variation margin as a topic for a podcast.

It is potentially the most boring, the most “turn offy” subject that you could ever think of to put forward as a topic. And so let’s see if we can make this work because I think what the blog does is it highlights a couple of things in the industry which are really kind of endemic to what we do. There’s a consultation out there from a regulator that proposes a number of things to do with variation margin that central counterparties call.

And if you don’t have any experience of the industry, if you’re a graduate, if you’re Chris Barnes, back in 2002, you read this paper and you go, “Well, this is just an IT problem. Like somebody could just write a system and it would solve all of these problems.” And I’m sat here doing a podcast 22 years later, and if you go off and you read the blog, I’ve written the blog in a way that doesn’t really follow the paper, but follows my experience.

And it starts with a quote from the FT, which basically says, “Nobody wants to be called in default due to an operational error, due to something being broken, due to somebody in back office getting something wrong.” But back in the peak of COVID 19, that’s very nearly what happened because really big banks don’t expect all CCPs, all of a sudden start making intraday margin calls and 22 years of experience leads me to have a hell of a lot more sympathy for that than if I was a tech guy going, “Well, just solve it with blockchain. Like, these are just messages and you just need to make a payment.” And that is essentially all we’re talking about. So I’ve basically, I’ve written a blog, highlights a load of problems, really poor form for a tech firm like Clarus.

I haven’t proposed any solutions at all. But I thought I would write it in kind of a realistic way that says, “Look, these are known problems in the industry. It’s really important to get those known problems out there and talk about pragmatic solutions. It’s not only a tech solution that is needed here. You need to understand the business processes behind it.” It’s been an interesting enough topic that it kind of covers both variation margin and what we talked about on a previous podcast in term of fire drills.

And Optiva, who are one of the big high frequency traders who are also involved in these type of things, you know, noted that there is a massive lack of standardization in that fire drill process all of the CCPs run fire drills differently in the variation margin calls that are intraday. Everybody is calling it differently and giving you different times to meet the call. I’m not going to have time in a podcast to go through the content.

I would ask you to read the blog with that type of lens on, you know, I’ve taken a regulatory paper, tried to apply my experience of trying to get these complex projects done, taken my experience from a business perspective, whereby I was a trader saying, “I want to trade this contract. Why can’t I trade this contract?”

I didn’t say, “I want to trade this contract and be able to make sure that I can make all of the margin payments, even in the event of crisis.” And so people have to deal with these commercial pressures as well. Amir, I’m sure you’ve come across very, very similar types of projects and problems. Any particular questions on this topic?

Amir Khwaja: Nice blog, yeah, very interesting, right? And we all know how important VM is end of day, you know, to mark to market everyone’s positions, yeah, up and down, super important. So I guess the question I have is, on those few days when there’s a large market move and a CCP makes an intraday call in US dollars, they don’t really give the money back, do they? If the market moves again, as we know, often you get a big move and it reverses by the end of day. So those funds are not returned, which I think is a problem for clearing members. And then the end of their settlement happens. Are there moves to address that issue?

Chris Barnes: So it really boils down to what do people consider the role of a CCP? Because exactly as you say, on the face of it, that sounds really bad. But when you look at how end of day variation margin works, if we take swaps, you’ll have a variation margin call for your Euro portfolio, you’ll have a variation margin for your dollars and sterling, et cetera.

These intraday calls are made in a single currency and per CCP, it might be the member that chooses what currency they meet the intraday call in. It’s not necessarily the CCP. So the CCP is not necessarily issuing dollar calls to everybody, because if you issue a dollar call to a Japanese bank, they might find it substantially more difficult to meet that dollar call than settling it in yen.

If you’re a CCP that’s outside of the US, you might find accepting dollars just more difficult than accepting your local currency. But the underlying liabilities of the derivatives are not necessarily in that currency. So you can’t necessarily pass on the dollars that you get from one counterparty and give it to the other.

So you’re not necessarily going through VM pass through. Equally, those dollars that you receive intraday, that might be versus a sterling or a euro or a yen market move. And so you need to wait until those actual liabilities are settled in the ensuing variation margin run for the end of day to make sure that you’ve got those before you should give the dollars back as a prudent thing to do.

What the paper is saying is basically there’s a balance here somewhere. We’re looking for a standardized way of making sure that intraday calls doesn’t just mean that all members of a CCP are posting a load of cash to the CCP and the CCP ends up needlessly long of cash. We’re trying to find a balance whereby some of these intricacies can be resolved.

There are a lot of solutions proposed in the paper itself. The consultation is open now. I think the expectation is that some recommendations will come out of this process about how the existing processes could be made better.

Amir Khwaja: And also, you know, it occurs to me, so if you’re a large clearing member and you’re a member at I don’t know, at 5, 10, 20 CCPs.

Chris Barnes: 32, Amir. I counted 32 CCPs for a city.

Amir Khwaja: So yeah, I guess a few globals, member of 32, you want to have standards that they operate in a similar, consistent manner.

Chris Barnes: You really do. And so could we imagine a world whereby we go away from single end of day variation margin runs and we go to every CCP doing three a day, just so that they can be sure in a crisis, they are compressing that period of time to exposure.

That would seem like kind of, what’s the phrase, “a sledgehammer to crack a nut?” Like maybe an overreaction to what I want meant to be once in a hundred year events. And so I did really appreciate the pragmatic tone. That yeah, paper tuck so that people are not motivated by the consultation to go, “This is the Nirvana state, and this is what we should work towards.” It said, you know, transparency is an obvious first step. Just make it really, really, really clear that this can happen, and this is when it can happen.

Amir Khwaja: The thing that interests me always is, you know, the huge flows that move back and forward every day between member firms and CCPs and clients.

The amounts are billions are moving back and forwards, back and forwards. Question is, should they move more frequently? Should they move less?

Chris Barnes: But I think the risk with writing content like this and the risk of having consultations like this that make it into the press is that everybody goes, “Oh, this is bad, and CCPs are bad.” On the flip side of that, exactly as you’ve just said, they’re moving billions and billions and billions all of the time and nothing happens. This is why I started with variation margins, such a boring topic because it just happens and nothing bad ever goes on.

Amir Khwaja: Great. Thanks, Chris.

Chris Barnes: On that note, Ali. I really hope that I will be invited back one day. I realize normally it’s like three strikes and you’re out. But SACCR has done well on our listens and Cross Currency is up there. So hopefully, variation margin, this won’t be my last ever podcast.

Ali Curi: Chris, you’re always welcome back to the podcast.

Chris Barnes: Very kind.

Ali Curi: Thank you. Please share with us again the title of your blog post.

Chris Barnes: Simply called “Best Practices for Variation Margin.”

Ali Curi: Great, that works. Chris Barnes, Amir Khwaja, thank you both for sharing your Quick Takes. Let’s do it again next week.

Chris Barnes: I really hope so.

Amir Khwaja: Thanks Ali.

Ali Curi: And that’s our episode for today. You can read more about these topics on the Clarus blog, and you can follow ION Markets on X and on LinkedIn.

Thank you for joining us.