Changes to initial margins on spreads that the London Metal Exchange’s clearing house LME Clear will bring in on March 3 will reduce the total margins that its members must post to the clearing house by $300 million or 3%, LME Clear chief executive Trevor Spanner told Metal Bulletin.
LME Clear has introduced a new method of calculating margin for the inter-prompt spread that takes account of whether any given market is in contango or backwardation, parameters that were never previously used to calculate margins, it told members in a notice on February 25.
“Overall, we believe this is an improvement in terms of the relevance and accuracy of a model, and that it will bring down margin balances that members must post to LME Clear,” Spanner told Metal Bulletin.
LME Clear members post initial margin to enable the clearing house to act as a central counter-party to the other side of contracts they buy or sell, protecting both sides in the event of default by the other.
When LME Clear was launched, the highest priority requirements of members were that margins be relatively stable, and that more of the risk coverage be single and covered by margin, and less of the risk coverage be mutualised in the form of the default fund, Spanner said.
“But there was also a wish list, which included the refinement that margins should reflect whether the market was in backwardation or in contango.
“The market has never had margin parameters that took account of backwardations or contangos before. Since backwardated markets are typically more volatile than ones in contango, this meant that previous calculations of margin were less sensitive to risk than the new model,” he said.
Spanner said the requirements that margins be stable and that the default fund cover less of the total risk had also been met.
The default fund had fallen to $503 million from $620 million at the launch of LME Clear on September 22.
Meanwhile, during the sharp falls in copper prices seen in January, “all our margin models worked, and we didn’t see any breach in parameters” that would have led to changes in initial margins, he noted.
In terms of product development, LME Clear is looking at taking collateral in yuan, as well as the possibility of using warrants to collateralise positions, Spanner said.
"These would be classified as single-use warrants, allowing aluminium warrants to be used as margin against aluminium, copper warrants against copper positions and so on," he said.