Prompt and transparent margining and, where possible, central counterparty (CCP) clearing helps avoid the situation in which the perceived stress on one major participant can cause a panic which amplifies stress across the market due to uncertainty about who else, is exposed – and whether those exposures are adequately protected by sufficient margin.1 As a result of those reforms, the financial system entered the Covid crisis in a much stronger position with regard to collateral and counterparty credit risk, with, for example, at least $ in additional collateral against over the counter (OTC) derivative exposures.2 Very significant and sudden changes in asset prices did not lead to counterparty credit risk – actual or anticipated. Margin call is of course pro-cyclical, insofar as it reflects movements in markets. This is not a bug in the system, it is a feature. As markets move, losers have to pay variation margin to winners. And as risks grow, initial margin rises to protect the members of a clearing house from the consequences of a future default by other members. This characteristic of margin is unavoidable if we are to ensure that collateralisation keeps pace with risks and counterparty credit risk is minimised. But it is right to try to dampen this dynamic to the extent practicable and to avoid unwarranted procyclicality. Against that background, let me set out the findings of the FSB group on margin and the proposed next steps.
Unlike 2008, the solvency and liquidity of the banking system was not at the very forefront of market and regulator concerns. And, of course, the shock itself did not originate in the financial system but rather in a once-in100 year pandemic that has left us with many other, more powerful, and disturbing memories. But it is worth refreshing our memories about just how extraordinary were the events of late February and March 2020. The realisation that we were facing a global pandemic – and that, in order to contain it, large parts of the global economy would need to be shut down – sparked a reassessment of financial asset values and, as one would expect, a ‘flight to safety’ by investors. In February 2020, as you would expect, risky asset prices fell sharply. At the same time, the price of traditionally safe assets rose sharply and yields fell – the yield on US treasuries for example fell by around 100 bps. This flight to safety was also reflected in the gold price, which rose by around 4% over this initial period. In the early weeks of March however – from the 9th to the 18th – a different dynamic took hold; an accelerating ‘dash for cash’ in which, given the illiquidity of other markets, investors sold their most liquid assets, driving safe asset prices down. A dash for cash which turned into a stampede. The numbers are impressive.