Margin and Clearing: Collateral and Valuation#
See also
Margin requirements for non-centrally cleared derivatives, the BCBS-IOSCO standard (now part of the Basel Framework)
ESMA post-trading, for EMIR
After the 2008 crisis, the G20 agreed to reduce the risk in the over-the-counter (OTC) derivatives market. The reforms rest on clearing standardised derivatives through a central counterparty (CCP), requiring margin on those that are not cleared, and reporting all trades to trade repositories. They are covered by EMIR in the UK and EU and by Title VII of the Dodd-Frank Act in the US.
This page covers only the parts that matter for valuation. The history is in XVA: An Introduction to Valuation Adjustments, and the cost of funding initial margin is in MVA: Margin Valuation Adjustment.
The rules in brief#
Rule |
What it requires |
|---|---|
Central clearing |
Standardised OTC derivatives, such as most interest rate swaps and credit default swaps, are cleared. The CCP becomes the counterparty to both sides, collects initial and variation margin, and marks the trades to its own end-of-day curves. |
Variation margin (VM) |
The daily exchange of the change in market value of the netting set, for non-cleared as well as cleared trades, so that the current exposure is close to zero. It has applied to most financial counterparties since 2017. |
Initial margin (IM) |
Margin posted by both parties for the potential move in value during the margin period of risk. It is calculated at a 99% confidence level, usually with the ISDA Standard Initial Margin Model (SIMM), and held with a third party. It was phased in by size between 2016 and 2022. |
Reporting |
Each trade is reported to a trade repository, with its valuation, which is updated daily for the exposures. |
Why they matter for valuation#
Collateral changes how a derivative is valued, which is why the rules appear in the XVA series:
Discounting: a collateralised trade is discounted at the rate paid on the collateral, such as an overnight rate in the collateral currency. The CSA terms therefore decide which curve is used.
CVA and exposure: variation margin cuts the exposure to the margin period of risk. See CVA: Credit Valuation Adjustment.
FVA and MVA: the cost of funding variation margin and initial margin. See FVA: Funding Valuation Adjustment and MVA: Margin Valuation Adjustment.
ColVA: the options in the collateral agreement, such as the choice of currency, change the value of the trade. See ColVA: Collateral Valuation Adjustment.
A valuation control view#
CSA data drives the valuation: the eligible collateral, currency, thresholds, minimum transfer amounts and interest terms decide the discount curve and the exposure. An error in the trade data changes the valuation of the whole netting set, so valuation control checks them against the legal documents.
Margin disputes are independent evidence: when a counterparty disputes a margin call, it is telling the bank that its mark differs. The size and the cause of the disputes are a source of counterparty price evidence, which is most useful for illiquid products where little other evidence exists. A pattern of disputes in one product or with one counterparty is a signal to investigate the mark.
CCP prices are a strong benchmark: cleared trades are marked at the CCP’s end-of-day curves, which are among the best independent evidence for cleared products. Differences between the bank’s mark and the CCP’s should be explained.
Reported valuations: the mark-to-market sent to the trade repository should be consistent with the book value, so the figure has to reconcile.
IM models: the SIMM implementation and the CCP margin replication need validation, as they are inputs to MVA.