Portfolio Margining in Focus

Terry Flanagan

A system to allow futures traders to maintain margin balances based on a portfolio rather than individual positions is gaining traction amid regulatory changes and the buy side’s need for capital efficiency.

“With new bank regulation coming in and client clearing responsibilities now being imposed globally…capital for trading is going to become increasingly more scarce,” said Jeff Sprecher, chief executive of IntercontinentalExchange. ‘As a result of that, portfolio margining (will be) increasingly more important.”

As defined by the Commodity Futures Trading Commission, portfolio margining is a method for setting margin requirements on a portfolio basis, factoring in the potential for losses on some positions to be offset by gains on others. Required margin for a portfolio is set equal to an estimate of the largest possible decline in the net value of the portfolio, typically a much lower burden than being required to post full margin on each position separately.

“One of our significant value propositions is portfolio margining,” said Phupinder Gill, chief executive of CME Group, the world’s largest futures market, on an Aug. 1 conference call to discuss second-quarter earnings. “Four clearing members are now live with our solution, and we expect an additional two to three to be live by the end of this month.”

Phupinder Gill, CME Group

Phupinder Gill, CME Group

Given that portfolio margining can result in lower absolute margin levels, there is some wariness, especially since the global financial crisis of 2008-2009 remains seared in the memories of many market participants, operators, and regulators.

The efficiencies of portfolio margining must be balanced “against the need and desire of the market to not under-margin somebody, particularly a multi-asset-class company, like a bank, that could become systemic,” Sprecher said on a conference call to discuss ICE’s second-quarter earnings. “So both prudent risk (managers) and regulators are going to go slow, I suspect, on how they allow portfolio margining to make its way through the industry.”

Atlanta-based ICE, which operates derivatives exchanges and clearinghouses, has worked with the CFTC and the U.S. Securities and Exchange Commission in developing a portfolio margining strategy, Sprecher said. One specific innovation in the area is portfolio margining of a securities account against a futures account, he added.

Portfolio margining “is working really well in our credit default swap area,” Sprecher said. “It attracted the buy side into our CDS clearing in the last few weeks. So portfolio margining does work.”

In a sense, portfolio margining can be considered a rarity among recent regulatory initiatives, as it can call for less from market participants rather than more.

“Financial innovations often stem from changes in either the tax or regulatory landscape, and the present era is no exception,” Rosewood Trading Chief Executive Howard Simons wrote in a recent report. “Legal and regulatory mandates to increase the capitalization ratios and lower the effective leverage of major traders is central to Basel III, Dodd-Frank, EMIR and MiFID II and as all of these initiatives attempt to link capitalization and margin requirements to measures of market risk, traders have a strong incentive to lower their net position risk to save on capital charges.”

Added Simons, “the massive capital efficiencies produced by portfolio margining for holding offsetting long and short positions in related products are more important than ever in the new legal and regulatory landscape.

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