Margin Call
A margin call is a demand that a party to a leveraged position or derivative post more collateral, usually cash, because the position has moved against it or the required margin has risen. If the call is not met, the counterparty can close the position.
Also called: variation margin call · collateral call · maintenance margin call · margin requirement
Two kinds of margin sit behind most derivatives. Initial margin protects against the loss that could build up while a defaulter's positions are closed out and replaced. Variation margin settles the change in a contract's market value as it happens. Exchanges collect variation margin on futures as prices move, and the BCBS-IOSCO standards for non-centrally cleared derivatives require covered firms to exchange the full amount of variation margin, with a zero threshold, on a regular basis such as daily.
A margin call is a liquidity event, not a verdict on solvency. A firm whose hedge is economically sound can still fail if the cash loss on the derivative is due today and the offsetting gain on the underlying business arrives in three months. AIG is the standard example: its swaps did not require collateral until its credit rating or the market moved past set triggers, and when both happened in September 2008 the collateral calls came faster than it could pay (see credit default swap).
Calls can also rise because the requirement itself rises. A central counterparty increases initial margin when markets turn volatile, and a lender raises its haircut on collateral, both at the moment cash is scarcest. On crypto exchanges the call is usually replaced by automatic liquidation (see perpetual futures). A payments business that hedges FX with a bank under a collateral agreement needs a cash buffer sized for a sharp adverse move, not an average one.
In practice
Margin terms are not fixed for the life of a trade. Counterparties and clearing houses can raise requirements in stress, which makes margin procyclical: it demands the most cash when markets are least able to supply it.
Example
A firm sells €10 million forward to hedge a receivable due in three months. The euro rises 3 percent against the dollar, so the forward shows a loss of about US$330,000. The bank calls for that amount in cash today, while the matching gain on the receivable is not realised until it is collected.
Learn more on Money Wiki
This page gives the short answer. Money Wiki has a longer guide to Margin Call, with more detail and background.
Commonly confused with
| Term | How it differs |
|---|---|
| Haircut | A haircut reduces the value given to collateral when it is posted. A margin call is a demand to post more collateral because the exposure or the requirement has changed. |
See also
- HaircutA haircut is the percentage by which a lender discounts the market value of collateral when deciding how much to lend against it. A 2 percent haircut means US$100 of securities supports a loan of US$98.
- Central CounterpartyA central counterparty is a clearing house that steps between the two sides of a trade, becoming the buyer to every seller and the seller to every buyer, so that each party's exposure is to the CCP rather than to the other.
- Credit Default SwapA credit default swap is a contract in which the protection buyer pays a regular premium to the protection seller, who pays out if a named borrower suffers a defined credit event such as default. It moves credit risk without moving the underlying loan or bond.
- Futures ContractA futures contract is a standardised, exchange-traded agreement to buy or sell an asset at a price fixed today, for delivery or cash settlement on a set future date. A clearing house stands between the two sides and collects margin.
- Perpetual FuturesPerpetual futures are futures-style contracts with no expiry date, mainly traded on crypto exchanges. Instead of converging with the spot price at maturity, their price is held near spot by periodic funding payments between holders of long and short positions.
- DerivativeA derivative is a contract whose value comes from the price, rate or event it references, called the underlying. It lets parties take on or shed exposure to that underlying without buying or selling the underlying itself.