Template:Variationmargindescription: Difference between revisions

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[[Variation margin]] is designed to remove the [[mark-to-market]] exposure to your counterparty under a {{tag|derivative}} transaction. On any day where any party is entitled to call for it (in this day and age, that’s usually any business day), that party can calculate the present [[market value]], or [[replacement cost]] of the transaction, and require the counterparty to deliver eligible [[collateral]] equal to that value (subject to {{csaprov|threshold}}s and {{csaprov|minimum transfer amount}}s).
[[Variation margin]] is a [[credit mitigation technique]] designed to minimise [[credit risk]] under [[derivative]] transactions. It requires derivative counterparties give each other [[collateral]] — typically [[cash]] — each day to ensure that their net collateralised exposure is (more or less) nil. For example, if the net [[replacement value]] of the swaps between two counterparties on a given day is $10 million, the “[[out-of-the-money]]” party, who would have to pay it were all the transactions terminated, has to pay the “[[in-the-money]]” counterparty $10 million in [[cash]] (subject to agreed {{csaprov|threshold}}s and {{csaprov|minimum transfer amount}}s). This happens every day; variation margin can be paid either way, depending on how the net portfolio moves. [[volatility|Volatile]] markets can quickly move — a day is a long time when [[black swan]]s are on the wing — so parties often want a little something extra to tide them over for expected movements between now and the next variation margin payment date. For that, you need [[initial margin|''initial'' margin]].
 
This has the effect of re-setting the total exposure to (more or less) nil, and means that you can, for a brief moment, relax, safe in the knowledge that your shirt is safe. But volatile markets can quickly move — a day is a long time when [[black swan]]s are migrating — so you might want something to tide you over for expected movements between now and when you can next call for margin. For that, you need [[initial margin]].
 
There is an argument that [[variation margin creates more problems than it solves]]. But more or less the entire might of the global regulatory apparatus is stacked against that view, so take it in the contrarian view in which it is offered.

Revision as of 17:39, 22 January 2022

Variation margin is a credit mitigation technique designed to minimise credit risk under derivative transactions. It requires derivative counterparties give each other collateral — typically cash — each day to ensure that their net collateralised exposure is (more or less) nil. For example, if the net replacement value of the swaps between two counterparties on a given day is $10 million, the “out-of-the-money” party, who would have to pay it were all the transactions terminated, has to pay the “in-the-money” counterparty $10 million in cash (subject to agreed thresholds and minimum transfer amounts). This happens every day; variation margin can be paid either way, depending on how the net portfolio moves. Volatile markets can quickly move — a day is a long time when black swans are on the wing — so parties often want a little something extra to tide them over for expected movements between now and the next variation margin payment date. For that, you need initial margin.

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