CME Clearing has in recent years put an emphasis on capital efficiency for its clearing clients, and 2019 was no exception. Key initiatives such as a revamp of its portfolio margining programme were put to the test in 2020 during the volatility in March and April amid economic lockdowns, sliding financial markets and the negative pricing of WTI oil price futures. It came through with flying colours.
In August last year it announced production testing to enhancements of its OTC interest rate swaps margin model in order to drive capital savings for clients.
The changes went live in November and, when the coronavirus crisis hit in March, savings peaked at a record $7.04bn, having reached $4.6bn in February.
“We realise that for participants the most important thing we can do is to give them the optimal way to deploy their capital and to get savings as they carry their risk,” says Sunil Cutinho, president of CME Clearing in Chicago. “It’s far more important for them than having additional products cleared in the OTC space.”
Cutinho says that more is to come from the programme. “We have been focused on this over the last year so the portfolio margining programme gives enhanced savings on futures and swaps and in the later part of this year we plan to expand that to listed options.”
The coronavirus pandemic was a test for all market participants, with implied volatility in equities giving 1929 and 1987 a run for their money and crude oil futures settling in negative territory for the first time ever. CME was well positioned.
“Volatility in March did spike to unprecedented levels but against this backdrop we didn’t have to do anything unusual and followed our normal process,” says Cutinho. “Our margin changes were very measured.”
Total aggregate margin went from $150bn to $240bn, and collateral reached about $254bn in the period amid a surge in traded volumes; but in aggregate margin changes were only around 10% and were smoothly implemented.
“We gave our participants 24 hours’ notice before any change, so they were not surprised and clearing firms had the opportunity to manage their exposures so there were no surprises, and there was predictability,” says Cutinho.
“It all worked because of all the effort we put into correctly set margin levels.”
CME also took steps to make its margin calculations more robust by implementing a new way to manage stressed value-at-risk (VAR). Designed to mitigate against procyclicality in margins, stressed VAR previously used long periods of look-backs.
“From a risk perspective, it’s not optimal because the weights that you place on the scenarios keep going down,” says Cutinho. “We have changed to fixed weights to make sure that the margins remain high enough — and that also played a role in how we weathered the experience this year.”
Market participants have given a warm welcome to these measures, which have made calculations both more robust and more efficient.
“Within this context of unprecedented volatility, people would like to use the same amount of capital to manage their risk efficiently, so this played really well and this is what shows up in March — and is a direct result of the changes that we put into place,” Cutinho says.
The pressure on clearing houses and exchanges has been unrelenting, with April bringing the oil crash that led to the May WTI future trading negative. CME was well prepared, advising participants at the beginning of the month that all of its clearing and trading systems were ready, and giving firms time to use its testing environment.
“We were the leaders, with our counterparts across the Atlantic taking our cues to prepare for negative prices,” says Cutinho. “We co-ordinated with them and adjusted options pricing models in a short space of time.”