When variation margin attacks: Difference between revisions

CAPTAIN RUM: The crew, milord? What crew?<br>

BLACKADDER: I was under the impression that it was common maritime practice for a ship to have a crew. <br>

Since, like Captain Redbeard Rum, your loyal contrarian is going to run against what all the other captains will tell, you, let me set the scene with a story.

Now here is an interesting thing. Because [[Archegos]] gained their market exposure using [[Equity derivatives|swaps]], ''by regulation'', their brokers were ''obliged'' to pay out their realised gains<ref>For [[prime broker]]<nowiki/>s charging “[[dynamic margin]]” this was partly offset by the effect of increased [[initial margin]] required on the inflated value of the position in question; for those charging only a [[static margin]] amount, there was not even that fig-leaf. </ref> or “[[net equity]]”, every day, in cash, in the form of [[variation margin]].  To be sure, the broker usually pays [[VM]] into a bank account it runs for its client. There are withdrawal thresholds that apply to that account that takes into account required [[initial margin]] — oh, that’s another story altogether — but over those thresholds all the variation margin is the client’s money, available to be withdrawn on request.  

This is completely normal in the world of latter-day [[Derivative|derivatives]]: mandatory two-way exchange of [[variation margin]] was implemented by regulation in pretty much every major market ''in the name of reducing systemic risk'' — but all the same, in the context of [[Archegos]], it does look weird. It is like ''forced'' [[swap dealer]]<nowiki/>s to extend additional lending against asset appreciation, regardless of the likelihood that the asset might then ''de''preciate again. Imagine if your bank, by law, had to pay you the cash value of any increase in your home’s value over the life of your mortgage.  

Had Archegos put the equivalent ''physical'' positions on, using [[margin loan]]s, its [[prime broker]]<nowiki/>s would ''not'' have ''had'' to advance it the cash value of its [[net equity]]. Now to be sure they may well have ''willingly'' done so, of course –  lending on margin is how [[prime broker]]s make their money after all — but being ''able'' to lend money, and being ''obliged'' to lend money are quite different propositions on that special day when it seems the whole world is going to hell.<ref>It is fair to note that — with the possible exception of the vampire squid — [[Archegos]]’s brokers did ''not'' believe the world was going to hell, at least not until it was far too late. But the principle remains.</ref> And the more precipitately a position has gone ''up'', the more likely it is to come precipitately ''down'' again.