The death of Queen Elizabeth II has had a profound impact on the UK. And it’s not just the feeling of loss, there are some practical implications too; changing of TV and radio schedules, with wall-to-wall news coverage, the need to learn new words to the national anthem, and looking forward, changes to stamps, passports and money.
None of these, however, have got anything to do with margin. But the introduction of a bank holiday for the Queen’s funeral does. Because, with global markets and CCPs that cover multiple currencies, any bank holiday is going to impact one aspect or another of the margin calculation process.
The unplanned bank holiday on Monday the 19th September in the UK caused a number of last minute changes to trading activity, particularly as it fell two days before the third Wednesday – a key date for many contracts. LSEG closed all exchange traded markets. ICE closed trading in UK based interest rate, index and commodity contracts, but not power and gas. Eurex closed trading in UK equity and index contracts. CME group adjusted last trade and payment dates on some GBP based contracts. LME remained open, but cancelled the first ring and declared that the date was no longer a valid prompt for sterling based contracts.
Variation Margin
A bank holiday can cause sudden spikes in variation margin because of the global nature of markets. Although exchanges or contracts in the UK may be closed on a given day, similar markets in other countries may be open and vice versa. When the closed market reopens there can be a sudden jump in prices as trading catches up to realign the related products.
CCPs are aware of this and some will have special procedures in place to amend their closing/settlement price setting process, relying on related contracts rather than trading in the closed contracts. This solves the next day problem, but it doesn’t resolve intra day issues that have been observed.
As an example, take the NBP UK gas contract and the TTF Dutch gas contract that both trade on ICE. On a UK bank holiday, NBP will normally be closed and therefore there will be no intra day prices. This means that when intra day margin is calculated, the variation margin component for NBP will be zero.
However, the TTF market will be open and therefore priced intra day, leading to a variation margin component of any intra day requirements calculation. This is a particular issue for members who hold spread positions between NBP and TTF, and in the current volatile energy markets the resulting intra day margin call can be considerable.
Initial Margin
There are two ways that variation margin may be impacted on bank holidays, depending on whether it is a bank holiday for the CCP or a bank holiday for the product/settlement currency.
The major CCPs such as LCH, ICE and CME are only closed on days when all the products on the exchanges or OTC markets that they clear are closed. However the same is not true for some other CCPS who therefore have the risk that the price on a product that they clear will have moved significantly while they are closed. To counteract this they may call for additional initial margin overnight two business days before the bank holiday, for payment on the day before the holiday. Usually this is the normal margin multiplied by a scalar.
Where a CCP is open but it is a bank holiday for a market that they clear, the risk is the lack of settlement. A bank holiday means that it is not possible to get good value for the currency of the country. To cover this settlement risk the CCP may calculate additional margin, equivalent to the settlement amount but converted into the currency of the CCP, which must then be covered by available collateral.
What to look out for
Bank holidays are OK if everything you trade is covered by the same holidays as the CCP through which it is cleared. But where there is a mismatch there is a chance that you are going to see increases in your margin requirements. These are usually only temporary, with levels dropping back to normal on the day after the bank holiday, but they still need to be funded.
Examples include large intra day calls on spread positions where one side is not being priced and additional margin to cover the risk of a mismatch between the holidays associated with a product and the holidays of the CCP. Market participants need to make sure that they are aware of these potential additional margin calls and have the ability to predict what the impact may be based on their portfolio.