Handling Margin Calls

Both the side making a margin call and the side receiving it deliver the right amount by the deadline and keep funds ready for it. You may need to check the flow and deadlines of a call, the response when amounts do not match, and the preparation for sudden calls.

Calls that fill gaps in collateral

A margin call is a request for the counterparty to post or return collateral as market values change, in trades where the parties exchange collateral. Exchanging collateral protects against counterparty credit risk¹. Because market values move every day, the amount of collateral needed changes every day too. For trades covered by Japan's margin rules, a firm calculates two amounts each day for each counterparty: the total market value of the trades and the market value of the collateral. It then asks for variation margin to be exchanged².

When markets are volatile, though, calls of unexpected size can arrive together, and the demand for funds to meet them grows across the whole market. How well each participant copes depends on the size of its positions and on how well it has prepared its funds¹. Both sides therefore set up procedures for delivering the right amount by the deadline, and keep funds ready to pay it. How large the funding burden can become, and what happened in past periods of market stress, are covered in Funding Variation and Initial Margin.

The five steps of a bilateral call

A bilateral call runs in five steps, from valuation to delivery. In bilateral trades that do not go through a central counterparty, the collateral terms are set in a credit support annex (CSA) attached to the master agreement. The main terms are the threshold, which is the amount up to which no collateral is required; the minimum transfer amount, which is the smallest amount that is actually delivered; and how often the trades are revalued³. Margin rules require variation margin to be exchanged with a threshold of zero³. At the time of a 2017 paper, trades between financial institutions often used a threshold of zero. On revaluation frequency, weekly contracts were common in Japan, but daily contracts were increasing³.

Consider a hypothetical example in which T Bank and U Bank trade under a CSA, and the trades have a positive market value from T Bank's point of view.

1. Valuation: T Bank and U Bank each calculate the total market value of their trades with the other and the market value of the collateral already delivered.
2. Calculation of the required amount: Each bank works out the collateral that matches the total market value and the difference from the collateral already held. If the difference is at or below the minimum transfer amount, nothing is delivered that day.
3. Call: If the difference exceeds the minimum transfer amount, T Bank, which holds too little collateral, asks U Bank to post more. If values move the other way and T Bank ends up holding too much, U Bank asks T Bank to return the excess.
4. Agreement: U Bank, having received the call, checks the amount against its own calculation. If the amounts match, it agrees to the call. If not, the two banks move to their dispute resolution procedure.
5. Delivery: U Bank posts the collateral by the deadline, and T Bank confirms that it has arrived.

Figure description

T Bank and U Bank each value and calculate separately, and U Bank checks T Bank's call against its own calculation. If the amounts match, U Bank posts the collateral and T Bank confirms receipt. If not, the two banks move to their dispute resolution procedure. On a day when the difference is at or below the minimum transfer amount, there is no call and no delivery.

When the threshold is zero and the collateral is cash, the amount to deliver, $X$, is given by the following formula.

$$X = V - C$$

$V$ is the total market value of the trades from T Bank's point of view, and $C$ is the collateral T Bank holds (negative when T Bank has posted collateral). If $X$ is positive, U Bank posts that amount to T Bank. If it is negative, T Bank returns collateral to U Bank or posts collateral to it. If the size of $X$ is at or below the minimum transfer amount, nothing is delivered.

Consider a hypothetical example in which the threshold is zero, the minimum transfer amount is 50 million yen, and the collateral is cash. By the end of the previous day, T Bank holds 800 million yen of collateral from U Bank.

On day 1, the difference of 200 million yen exceeds the minimum transfer amount, so U Bank posts 200 million yen and the collateral rises to 1 billion yen. On day 2, the difference of 30 million yen is at or below the minimum transfer amount, so nothing is delivered, and 30 million yen of T Bank's exposure remains uncollateralized. On day 3, the market value falls to 700 million yen, the difference becomes −300 million yen, and T Bank returns 300 million yen to U Bank. On days when values move in T Bank's favor, U Bank pays out funds, and on days when they move against T Bank, T Bank pays out funds. How much the threshold and minimum transfer amount reduce exposure (the amount that could be lost if the counterparty defaults) is covered in Risk Reduction through Netting and Collateral.

Japan's margin rules require a firm to make a call immediately when the size of $X$ exceeds an amount the parties have set in advance. This amount, together with the corresponding amount set for initial margin, must be no more than 70 million yen. Once the difference exceeds this amount, the firm asks for the whole difference, so the amount works like a minimum transfer amount rather than a threshold. The side making the call receives the collateral without delay, and the side receiving the call complies².

Central counterparty calls follow amounts and deadlines set in the rules

With a central counterparty, the central counterparty calculates the amount of each call by the method set out in its rules and gives notice of it, and the clearing participant delivers by the deadline in the rules. The example here is interest rate swap clearing at Japan Securities Clearing Corporation (JSCC).

JSCC calculates the required variation margin from the change since the previous business day in the net present value of the trades being cleared. Variation margin is paid and received in cash in the currency of the trade, every business day⁵. For yen trades, a clearing participant that pays deposits the amount with JSCC by 11:00 a.m. on the business day after the calculation date. JSCC pays the receiving clearing participant without delay from 1:30 p.m. For foreign currency trades, the deadline is 11:00 a.m. on the first day after the calculation date that is a business day for both JSCC and the currency's market. JSCC pays from 1:00 p.m. that day without delay⁵.

Separately, every business day JSCC calculates the required intraday margin, which is part of initial margin, and notifies clearing participants. If the initial margin a clearing participant has deposited falls short of this requirement, the participant deposits the shortfall by 3:30 p.m. on the day the shortfall arises⁶. Intraday margin can be deposited in yen or US dollar cash, and also in Japanese government bonds or US Treasury securities⁷. JSCC can also require an extraordinary deposit of variation margin, setting the amount and method each time, for example when market conditions change sharply⁸.

At the time of a 2017 paper, the UK central counterparty LCH and JSCC made several margin calls a day to keep exposure as low as possible⁹. The FSB's recommendations for non-bank market participants ask them, to prepare for intraday calls, to understand which counterparties can make such calls, which trades and circumstances lead to them, and whether the calls are recurring or ad hoc¹⁰.

Compared with bilateral trades, the differences are as follows.

When call amounts do not match

If the parties differ on which trades to include in the total, or on how to value the trades and the collateral, the call amounts each of them calculates will not match. The gap is resolved by a method set in advance.

Take day 1 of the earlier example, with a threshold of zero and collateral held, $C$, of 800 million yen. T Bank values the trades at $V$ = 1 billion yen and calls $X = 1,000 − 800 = 200$ million yen. U Bank values the same trades lower than T Bank does, at 960 million yen, and calculates $X = 960 − 800 = 160$ million yen. The call of 200 million yen differs from U Bank's own figure of 160 million yen by 40 million yen, so U Bank cannot simply comply. The banks move to their dispute resolution procedure. Which amount is delivered depends on what the parties agreed in advance: 200 million yen if the agreed method follows T Bank's valuation, or 160 million yen if it follows U Bank's. If the valuations differed in the opposite direction, U Bank's figure could be the larger one.

Under Japan's margin rules, when the two calculated amounts differ, the side making the call receives the amount calculated by a method both parties agreed in advance. For variation margin, it receives this amount without delay. For initial margin, it receives this amount first and then promptly resolves the remaining difference¹¹. The Financial Services Agency's supervisory guidelines list points for checking a financial instruments business operator's control framework. One is whether the operator works to decide in advance how to handle margin disputes, respond to them appropriately, and record and keep the details of each dispute¹². The FSB's recommendations also list clear dispute mechanisms and a system to track and manage outstanding disputes¹⁰.

When a counterparty defaults, disputes and other factors mean that some time passes between the last exchange of collateral and the completion of closing out the trades³. This period is called the margin period of risk (MPOR). Even with daily margin calls, exposure can move a great deal during the MPOR³.

What happens when collateral is not delivered by the deadline

Central counterparties set out in their rules what happens when a participant cannot pay by the deadline. For JSCC interest rate swaps, a settlement default occurs when a clearing participant does not perform an obligation by the deadline, or is at risk of not doing so¹³. Once JSCC declares a settlement default, it suspends, to the extent and for the period needed, its acceptance of new trades to which that participant is a party and its delivery of money and other assets to that participant. JSCC can apply the suspended money and assets to paying off the participant's obligations to JSCC¹³.

When JSCC declares that a clearing participant has defaulted, that participant's cleared trades terminate on the day of the declaration without any declaration of intent by the parties¹³. For interest rate swaps, JSCC disposes of the defaulted participant's positions through an auction in which other clearing participants take part¹⁴.

In bilateral trades, what happens when collateral is not posted depends on the master agreement and the CSA. The FSB's recommendations ask participants to build the mechanics of their CSAs, and any clauses triggered by credit deterioration or any termination events, into their estimates of funding needs under market stress¹⁵.

Estimating calls in advance and preparing funds

The FSB's December 2024 report asks non-bank market participants to prepare their funds for margin calls¹⁶. Participants estimate in advance, through stress testing, the funding strain that margin calls can cause, and use the results to decide how much funding and collateral to keep on hand¹⁷. For calls that can be met only in cash, they keep cash, or reliable sources of funds, that they can pay with a high degree of certainty both in normal times and when markets are volatile. The cash should be usable in the called currency, in the time zone of the call, and at the place of delivery¹⁸. For calls that can be met with non-cash assets, they keep sufficient and diversified collateral, and allow for haircuts, the discounts applied to the value of collateral¹⁸.

Participants test that the assets they intend to use as collateral are unencumbered and usable within the time required, including for intraday calls¹⁰. Supplementing funds on hand with committed credit lines and similar sources, and reviewing CSA terms with counterparties so that non-cash collateral can be posted, are also listed as ways to prepare¹⁸. For JSCC interest rate swaps as well, variation margin is paid and received in cash in the currency of the trade, so a firm needs cash to pay variation margin even if it holds government bonds⁵.

For financial instruments business operators, daily cash management and securing funding sources in case of sudden changes in the business or in market conditions are given as examples of points to check in liquidity risk management in the Financial Services Agency's supervisory guidelines¹⁹.

Notes

1. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Section 1.1 (page 5; page 9 of the PDF). ↩ ↩²

2. "金融商品取引業等に関する内閣府令" (Cabinet Office Order on Financial Instruments Business, etc., in Japanese), Article 123, paragraph 1, item 21-10 (a) (daily calculation of the values of trades and collateral), (b) (immediate call; this amount, together with the amount under item 21-11 (b) of the same paragraph, is no more than 70 million yen), (c) (receiving without delay), and (d) (complying with the request). ↩ ↩²

3. Yuichi Saito, "金融規制の複合的影響を考慮したXVA" (XVA taking into account the combined effects of financial regulations), Kinyu Kenkyu, Institute for Monetary and Economic Studies, Bank of Japan (April 2017), Section 3 (1), "イ．信用極度額" (a. threshold), "ロ．最低受渡担保額" (b. minimum transfer amount), "ハ．評価頻度" (c. valuation frequency), and "ニ．適格担保" (d. eligible collateral), pages 116–118 (in Japanese). The paper calls the threshold "信用極度額," the minimum transfer amount "最低受渡担保額," and the margin period of risk "リスクのマージン期間（MPR）." ↩ ↩² ↩³ ↩⁴ ↩⁵ ↩⁶

4. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Annex 3, the example for Recommendation 6 (page 30; page 34 of the PDF). ↩ ↩²

5. Japan Securities Clearing Corporation, "金利スワップ取引清算業務に関する業務方法書" (Business rules for the interest rate swap clearing business, in Japanese), Article 77 (payment and receipt of variation margin), Article 78 (required amount of variation margin), and Article 81 (deposit deadline for variation margin; 11:00 a.m. and 1:00 p.m. for foreign currency trades), pages 66–67; Article 2, item (4)-4 (home-country business day), page 3. ↩ ↩² ↩³

6. Japan Securities Clearing Corporation, "金利スワップ取引清算業務に関する業務方法書" (Business rules for the interest rate swap clearing business, in Japanese), Article 2, item (54) (intraday margin is the part of initial margin deposited under Articles 67 to 70), Article 68 (calculation and notice of required intraday margin), and Article 70, paragraph 1 (deadline for depositing intraday margin), pages 9 and 62. ↩

7. Japan Securities Clearing Corporation, "金利スワップ担保・決済" (Interest rate swap collateral and settlement, in Japanese), "当初証拠金、日中証拠金及び清算基金の差入れ及び返戻並びに変動証拠金の決済方法" (Methods for depositing and returning initial margin, intraday margin, and the clearing fund, and for settling variation margin). ↩ ↩² ↩³ ↩⁴

8. Japan Securities Clearing Corporation, "金利スワップ取引清算業務に関する業務方法書" (Business rules for the interest rate swap clearing business, in Japanese), Article 82 (extraordinary deposit of variation margin), page 67. ↩

9. Yuichi Saito, "金融規制の複合的影響を考慮したXVA" (XVA taking into account the combined effects of financial regulations), Kinyu Kenkyu, Institute for Monetary and Economic Studies, Bank of Japan (April 2017), footnote 8 on page 117 (in Japanese). ↩

10. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Section 3.3, Recommendation 6 (page 18; page 22 of the PDF). ↩ ↩² ↩³

11. "金融商品取引業等に関する内閣府令" (Cabinet Office Order on Financial Instruments Business, etc., in Japanese), Article 123, paragraph 1, item 21-10 (c) (variation margin) and item 21-11 (c) (initial margin). ↩

12. Financial Services Agency, "金融商品取引業者等向けの総合的な監督指針" (Comprehensive guidelines for supervision of financial instruments business operators, in Japanese), IV-2-4(4)③ロ ("当初証拠金及び変動証拠金共通" (common to initial margin and variation margin); disputes over margin). ↩

13. Japan Securities Clearing Corporation, "金利スワップ取引清算業務に関する業務方法書" (Business rules for the interest rate swap clearing business, in Japanese), Article 2, item (15) (definition of settlement default), page 4; Article 89 (measures in the case of settlement default, insolvency, and similar events); and Article 91, paragraph 1 (forced termination of cleared contracts), page 74. ↩ ↩² ↩³

14. Japan Securities Clearing Corporation, "リスク管理 参加者破綻処理" (Risk management: handling participant defaults, in Japanese), as of February 13, 2018. ↩

15. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Section 3.2, Recommendation 5 (page 17; page 21 of the PDF). ↩ ↩²

16. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Section 1 (page 3; page 7 of the PDF). ↩

17. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Section 3.2, Recommendation 4 (page 16; page 20 of the PDF). ↩ ↩²

18. Financial Stability Board, "Liquidity Preparedness for Margin and Collateral Calls: Final report" (December 10, 2024), Section 3.3, Recommendation 7 (page 19; page 23 of the PDF). ↩ ↩² ↩³

19. Financial Services Agency, "金融商品取引業者等向けの総合的な監督指針" (Comprehensive guidelines for supervision of financial instruments business operators, in Japanese), IV-2-5(1) (main points for liquidity risk management). ↩