The CME Margin Notice That Has Everyone In a Tizzy

Last night the CME sent out a margin advisory.   They do this all the time, changing margin requirements in different products, but this notice was different:

The notice was picked up (and spread, like financial news Herpes) by ZeroHedge, who predicted a plethora of margin calls on Monday, and of course, imminent Financial Armageddon.  There is of course an alternative potential explanation.

Note the phrasing of the CME’s announcement:  they used “initial/maintenance” ratio.  Now, the initial margin is almost always larger than the maintenance margin (initial margin is how much collateral you have to post when you buy the contract.  Maintenance margin is lower because otherwise you’d have to replenish your margin every time the contract falls in value – instead you only have to do it when you reach certain “maintenance” thresholds).

So the initial/maintenance ratios were previously greater than 1.0.  They are being LOWERED to 1.0.  There are two ways for this to happen, obviously:  1) Raise maintenance margin requirements or 2) lower initial margin requirements.  If the CME was hiking maintenance margins across the board, it seems that they could have more accurately used the term: “maintenance/initial” ratio to describe the change.

I am guessing that this change is, of course, related to the account transfers of MF Global customers.  Since accounts are being transferred to new clearing firms, that may trigger re-posting of initial margin requirements.  Reading from CME’s memo: “Quick Facts on Margin at CME Clearing,

“CME Clearing determines “initial margin,” which is the margin that market participants must pay when they initiate a position with a clearing firm.

The clearing house also determines “maintenance margin,” the level at which market participants must maintain their margin over time.”

Now, I can’t be sure, but I suspect that CME’s announcement from last night is a lowering of the initial margin requirements, to avoid the necessity of former MF Global clients having to post increased margin as a result of their positions being transferred to a new firm.  This isn’t chump change we’re talking about – here’s part of CME’s announcement from yesterday:

CHICAGO, November 4, 2011 – Today, CME Group continued to successfully transfer additional MF Global U.S. customer positions and CME Clearing-held collateral to other qualified clearing firms.  The remaining customer segregated positions are expected to be transferred by the end of the day, completing the total transfer of customer positions at CME Group exchanges in approximately 15,000 MF Global accounts and approximately $1.45 billion in associated clearing collateral, as approved by the Trustee and bankruptcy court.

Receiving commodity brokers for these transfers are responsible for notifying customers as to the new commodity broker for their accounts.

So, it is possible that during a time of financial market stress and uncertainty the CME has decided to jack margin requirements across the board for all products?   It’s possible – and their advisory notice was certainly ambiguous.   At this point, they have not updated the numbers on their website where all of the margin requirements are listed.    However, I think that the sane explanation here is that the CME is not raising margins across the board on all products – but rather lowering the initial margin requirements to AVOID triggering margin calls as they try to clean up the MF Global mess.

EDITthe CME has released a clarification. In part:

“Yesterday, CME Group successfully transferred MF Global customer positions to a new clearing member with part, but not all, of their funds, as approved by the bankruptcy trustee and the court. By reducing the initial margin “ratio” to 1.00, we ensure that margin calls that are issued to these transferred MF Global customers will be limited to bringing their accounts into compliance with the lower, “maintenance” margin levels. Maintenance margins are set to provide appropriate risk management coverage. Initial margins are set to provide an additional buffer against future losses in the account.”

Kinda almost like what I suggested above…. The CME wanted to make sure that transferred MF Global customer accounts were not subject to higher “initial” margin maintenance requirements when receiving margin calls at their new clearing firm – that they were not whacked with bigger margin calls.   Normally, margin calls require the customer to replenish their margin level up to the “initial” margin level.  This rule change lowers the “initial” level so that the customer only has to replenish their margin level up to the “maintenance” level, which is the level “set to provide appropriate risk management coverage.”

EDIT 2:  One implication of this change is that fully leveraged clients will no longer be posting “cushion” collateral above the maintenance margin level.  Normally, when you get a margin call, you have to bring your account equity up to the initial margin level, which provides a cushion so that you don’t get a margin call every single day that your position moves against you – you are fine until you hit that “maintenance” level.    Now, without that “cushion,” fully leveraged traders may see  (more frequent, smaller) margin calls every time their position moves adversely.

-KD

disclosure: no positions in $CME or $MF

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