CME issues Clarification on Performance Bond Requirements

This afternoon, the CME Group issued a clarification on their communique detailing the increase in performance bond requirements for it clearing member customer accounts with non-hedged positions. Evidently there was a great deal of confusion regarding the wording of the original release.

The Dow Jones wire service interpreted the original communique in the same manner as I did. I am not sure about Reuters but either way, the wording was so poor, that it forced another release to clarify it!

Here is the Dow Jones report:
 3:03 (Dow Jones) CME notifies members of its clearinghouse that starting
Monday, members will need to effectively double the initial margin collected
for non-hedge trading positions, with no exception for members' customer
accounts. The move is required by CFTC as part of Dodd-Frank, While market
participants have known about it for some time, CME apologized Wednesday for
the "short notice" of the change. As per CFTC rules, hedges must reduce risk
for commercial users of derivatives markets, linked to such a company's assets
or liabilities. (jacob.bunge@dowjones.com)


In speaking with a rep from the CME, the change will affect a relatively small subset of traders and not have the drastic impact, that many traders, myself included, originally believed based on the initial news release.

Following is the complete news release:

DATE: May 2, 2012
TO: Clearing Member Firms
FROM: CME Clearing
SUBJECT:
Important Clarification
Note: the original version of this advisory was misleading regarding the applicability of the new rule and the manner in which "initial to maintenance ratios" work.

12-187 Performance Bond Requirements for Member Accounts: Effective this Monday, May 7, new CFTC Regulation 39.13(g)(ii) mandates each DCO to require its clearing members to apply "initial to maintenance ratios" for customer accounts with non-hedged positions. There is no exception for speculative customer accounts of exchange members that fall within the Regulation. The Regulation applies equally to positions that are regulated as futures and to positions regulated as swaps.
Note that the requirement only applies to non-hedged member accounts. Member accounts containing hedged portfolios are always assessed only at the maintenance requirement level. Most CME Group members engage in hedging activity on a routine basis -- for example, they make a market in one set of our products and lay off their risk in another set of products at CME Group or other markets. Such positions are still subject to hedge treatment. Note, however, that if you are a member and you have only outright positions you will be subject to the new rule.
For example, suppose you are a member and you qualify for hedge treatment. You have a portfolio with a maintenance requirement level of $100. The sole requirement you have is that $100 level.

On the other hand, suppose you do not qualify for hedge treatment, and your portfolio has a maintenance requirement level of $100 and an initial requirement level of $110. As long as you have $100 worth of value in your account, no margin call is issued. But Page 2 #12-187/May 2, 2012 if your collateral value falls below $100, then a margin call is issued to bring you back up to $110.

Previously, for futures, the use of "initial to maintenance ratios" applied only to accounts that were neither hedge nor member. Accounts are coded by FCMs as member, hedge or spec, and only accounts coded as spec had an "initial" requirement level that was higher than the "maintenance" level.

Note also that even for non-hedged member accounts, the higher "initial" requirement level only applies if (a) the account had no positions on the prior day, or (b) the value of collateral on deposit has fallen below the lower "maintenance" requirement. On all other days, it is the lower "maintenance requirement" which applies – which is the same level that the FCM is assessed – and so long as the account maintains a cushion of collateral value over the maintenance requirement, there is no margin call.

We believe that FCMs will be able to accomplish this change for member accounts which do not qualify for hedge treatment, simply by changing the account type that drives the margin calculation in books, from member to spec.

We apologize for the short notice about this change. See also Clearing Advisory 12-136, published March 28, about the use of initial to maintenance ratios for non-hedged positions in swaps, at:

http://www.cmegroup.com/tools-information/lookups/advisories/clearing/files/Chadv12-136.pdf