Procyclicality of CCP Margin Models: Systemic Issues Require Systemic Approaches

By definition, market risk models used to estimate initial margin, whether for centrally cleared or bilaterally cleared trades, must be sensitive to changes in market risk and therefore when market risk increases, requirements initial margin will tend to increase. To mitigate the potential effects of such procyclical behavior, CCPs have implemented various procyclicality mitigation tools. However, there seems to be renewed interest in the procyclicality of initial margin models after the March 2020 market crisis. In this article, we argue that the focus on initial margin models is misplaced. First, margin calls are largely driven by variation margin, not initial margin. Second, the inherent risk sensitivity of margin models, the stochastic nature of the problem, and the various trade-offs involved limit what can be achieved with model calibration. We illustrate why this is the case by empirically testing the performance of standard initial margin models during the events of March 2020 and quantifying the various trade-offs involved. If the weaknesses of the system therefore persist, how can they be remedied and who is responsible for resolving them? We argue that these questions require a systems perspective, focusing on the interactions between participants rather than a single node.