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→‎Voluntary margin

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 ===Voluntary margin===
-Now, none of this stops a dealer recognising the “equity” in a customer’s unrealised [[mark-to-market]] gains and lending against it. This is what [[Margin lending|margin lenders]] and physical prime brokers do every day of the week. But this kind of lending is ''discretionary''. Dealers don’t have to do it, and if they do, they can apply whatever [[haircut]]<nowiki/>s, credit terms and diversification criteria they like.
+Now, none of this stops a dealer recognising the “equity” in a customer’s unrealised [[mark-to-market]] gains and lending against it. This is what [[Margin lending|margin lenders]] and physical prime brokers do, every day of the week. But this kind of lending is, as lending should be, ''discretionary''. Dealers don’t have to accept the new trade, and if they do, they can impose whatever [[haircut]]s, credit terms, diversification criteria and other conditions they like. A customer who diesn’t like the terms can take its business elsewhere. This, as the [[Archegos]] situation illustrated, is plenty compulsion enough.
-As a customer’s unrealised profit increases in value, you would expect the dealer’s lending appetite to diminish. But regulatory VM rules ''force'' the dealer to lend in full, and in cash. Imagine if retail banks were forced to cash collateralise mortgage customers the value of unrealised gains on their properties!
+For, as a customer’s unrealised “profit” increases, you would expect the dealer’s lending appetite to diminish. Because unrealised profit ''is not profit''. It is the supposed attitude of the market without the single, vital signal that actual profit implies: ''sell''.
+In times of orderly function and normal liquidity, of course, that signal will be swamped by the hullabaloo of impulses flying around the market. It will be drowned out. But no-one risk manages for times of orderly function and normal liquidity. You risk manage for dislocation, sudden expected panic and market stampedes. Here the difference between your dealer’s last mark and your actual realised profit when you managed to get out can be vast. How vast? More than ten billion dollars, in [[Archegos]]’s case.
+But regulatory VM rules ''force'' dealers to lend in full, and in cash against untested marks, ''while investors’ capital is still at risk''. This is like expecting the house to pay out before the roulette wheel has landed, on an optimistic assessment of where it might. Imagine if retail banks were forced to cash collateralise mortgage customers the value of unrealised gains on their properties!
 “But, but, but, JC: there is a difference. A mortgage customer ''owns'' her house. She has no credit exposure to the bank for the house. If the bank fails, the customer keeps the house. With a swap, the dealer owns the hedge. If it fails, the customer would lose everything.”
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 All this is true. But, equally, the customer’s personal capital outlay for that house — her real investment — is small. A house is a levered play. A customer might technically “own” her house, but only in the very contingent sense that she keeps up her mortgage payments. ''She only owns the house as long as the bank gets its money''.
-The same is true of an equity swap. It is, as above, an implied loan. The customer puts down initial margin — economically equivalent to a deposit — and gets a levered return on the whole asset. The dealer earns only its commission on the opening and closing of the trade and, because it is funding its own hedge, takes a funding rate from the customer. Economically, the dealer has lent 70% of the initial value of the asset. If the customer wants to isolate its exposure to the dealer for its equity, it can take out a margin loan against a physical asset, just like a mortgage. Or it could close out its trade, take its profit and restrike par with the dealer.
+The same is true of an equity swap. It is, as above, an implied loan. The customer puts down initial margin — the economic equivalent of a deposit — to get a levered return on the whole asset. The dealer earns only its commission when it opens and closes the trade and, because of the implied loan, takes a funding rate from the customer. Economically, the dealer has lent 70% of the initial value of the asset. If the customer wanted to isolate its exposure to the dealer for its equity in that investment, it could take out a margin loan against a physical asset, just like a mortgage. Or it could frequently close out its trade, take its profit and restrike par and margin with the dealer.
+[[Buy-side]] counterparties are, [[Q.E.D.]], sophisticated professionals.<ref>They don’t get through onboarding if they are not. Sophistication is a condition to entry to the game.</ref> They have the tools, resources and skills to monitor their dealers’ credit standing. It is a ''much'' better discipline for them to prudently manage their own dealer credit exposure than to have dealers send them hard cash so they don’t have to. It is much more efficient. It simplifies the operational system.
+A customer’s failure shouldn’t be a systemic risk unless its unusual size, interconnectedness or other unintended system effects ''make'' it systematically important, in which case it should be regulated as if it is systemically important, and made to hold capital reserves.
-[[Buy-side]] counterparties are, [[Q.E.D.]], sophisticated professionals.<ref>They don’t get through onboarding if they are not. Sophistication is a condition to entry to the game.</ref> They have the tools, resources and skills to monitor their dealers’ credit standing. It is a ''much'' better discipline for them to prudently manage their own dealer credit exposure than to have dealers send them hard cash so they don’t have to. Their failure shouldn’t, typically, be a systemic risk unless their unusually size, interconnectedness or unintended system effects ''make'' them systematically important, in which case they should be regulated if they are systemically important, and made to hold capital, and (b) they have the market position and bargaining power to negotiate margin terms.
+Every dollar of margin a dealer pays to one customer reduces the capital it has available for everyone else. Dealer margin is a preference to that creditor over others. Unlike the preference afforded to retail depositors — on whose confidence a bank relies for its ongoing viability —there is no good grounds for preferring leveraged buy-side professionals in this way.
-Every dollar of margin a dealer pays to one customer reduces the capital it has available for everyone else. Dealer margin is a preference to that creditor over others. Daily [[mark-to-market]] moves are ''mainly'' ''noise''. Signal emerges only over time. A great deal of the back-and-forth of variation margin is, therefore, ''accommodating noise''. The signal only emerges over a prolonged duration. Over the short run posted collateral can, as we know a system effect: if I double down on an illiquid position, it will tend to rise, and I will get more margin, and — this is the story of [[Archegos]].
+Certainly not for daily [[mark-to-market]] moves, which are are ''mainly'' “noise”. ''Signal'' emerges only over time. The back-and-forth of [[variation margin]] therefore, simply ''accommodates noise''. Downward spikes in noise can certainly lay out levered investment funds, as we have repeatedly seenOver the short run posted collateral can, as we know a system effect: if I double down on an illiquid position, it will tend to rise, and I will get more margin, and — this is the story of [[Archegos]].
 The systemic risk caused by interconnected financial institutions failing — which is what the margin regs were designed to address — is not caused by the banks themselves, but by their customer exposures. Dealer risk is a function of customer failures, which in turn are a function of leverage. Paying variation margin to customers invites more leverage.