Margin mayhem must be made more manageable before another chaotic August strikes

By James Pike, interim CEO at Taskize

The brief but sharp global equity sell-off this summer was a wake-up call for financial markets, reminding us how quickly volatility can escalate into chaos. As markets grow more complex, firms must urgently reassess their margin operations to avoid a future catastrophe.

According to a recent Bank for International Settlements analysis on the so-called ‘carry trade unwind’ of early August which contributed to the market sell-off, the factors behind the volatility spike and major market movements largely remain unchanged, with several indications suggesting some heavily leveraged positions have already been rebuilt. From a margin perspective, one doesn’t require a crystal ball to foresee the uproar a much more violent bout of market turbulence could unleash.

The spike in volatility seen this August triggered margin calls across a wide array of markets and central counterparties (CCPs), giving rise to a market situation where volatile conditions force investors to sell assets, which in turn causes further declines in market prices. Data suggests the Japan Securities Clearing Corporation increased initial margins for long positions of equity indexes by 60-80%, while margins on short positions in Japanese government bond futures surged 43%.

Margin mayhem such as this poses a major operational headache for traders and operational teams, who face a whole host of challenges from liquidity pressure to the prospect of forced asset sales. However, while problematic, the size of the margin call isn’t the only issue traders and their counterparts face when bouts of market turbulence such as this arise.

There is also a much greater chance of margin disputes. These arise when counterparties find themselves at odds over the necessary funds or securities required to cover potential losses in an investment position. The intricacy of these disputes involves a delicate balance of risk, regulatory compliance and the financial stability of both parties.

Certain asset classes are also more troublesome when it comes to settling margin disputes. Consider the world of derivatives, many of which were affected by the August equities sell-off. There is an abundance of complex instruments, counterparties, and market dynamics at play in the derivatives arena – the intricacy of which only grows as market volatility rises. Take futures and options markets, for example. Disagreements over the calculation of margin requirements for these instruments are common, stemming from differences in opinions on the valuation of underlying assets and the unpredictable impact of market movements.

To mitigate the risk of any margin migraines amid elevated market turbulence, firms must prioritise collaboration and transparency when it comes to settling disputes. Establishing clearer guidelines for valuation methodologies and standardising communication channels can contribute to smoother resolution processes. Additionally, investing in technological solutions that automate and streamline margin calculations can significantly reduce the likelihood of disputes arising from human error or interpretation differences.

But most important of all is that firms make a swift appraisal of their margin approaches and procedures. If we have learned anything from the August sell off, it is that volatility incidents can emerge very quickly, and margin migraines follow fast on their heels.