How Asset Managers Can Drive Returns Amid Margin Spikes 

By Marcus Cree, Senior Risk Specialist at OpenGamma

Marcus Cree, OpenGamma

The last four weeks have seen massive disruption due to the ongoing Coronavirus pandemic, with huge market swings and a dramatic increase in volatility across the globe. This has caused margin rates, both Initial Margin and Variation Margin, to jump dramatically for fund managers at a time when they should be freeing up as much capital as possible.

To understand why margin rates have spiked so significantly, we need to look back a few decades. The process of globalisation has been accelerating now for over 30 years, creating a situation where today supply chains for virtually all industries span many countries and operate on ‘Just in Time’ inventories. The inherent vulnerability this presents to cross-border disruption has long been seen as a worthwhile price to pay for the benefits such an approach brings to production agility and price control.

COVID-19 has exposed the dark side of this vulnerability, with three decades’ worth of increasingly globalised supply chains being abruptly cut by the rapid closure of nation after nation’s borders. Meanwhile, demand is simultaneously being disrupted as consumers disappear into self-isolation with less money to spend and less incentive to spend it in the face of an uncertain future.

This disruption to supply chains all over the world comes at a time of historically low interest rates and high market volatility, leaving central banks very few options in terms of intervention. Initial Margin rates (the measure of risk) and Variation Margin (the measure of daily change) volatility have risen accordingly. With market volatility projected to continue on its upward trajectory, we can only expect further increases in margin rates in the weeks to come.

At this point in time, which is sure to go down in the markets history books, old approaches to trading can, more so than ever, lead to major capital and cost inefficiencies that could make or break a business. In short, every basis point counts.

For fund managers to maintain some level of control over margin in this ever-changing market, they must first understand what is driving their margin calls and begin looking at margin as a front-office concern. By employing the right data analytics, they can drastically improve collateral management by calculating the total cost of a trade and considering their options before execution – such as different trading decisions, or different broker and CCP choices for various strategies. If they follow this approach, they will be able to drive potentially substantial savings, directly freeing up more cash to drive returns.

As worried investors increase their scrutiny of every penny, more fund managers will need to seek out in-depth analysis in order to reduce the effects felt by supply chain disruption. By optimising margin, they will ensure huge sums of money are not left on the table which could be put to work making material returns.

The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine, Markets Media Group or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community.