Margin (Collateral) and Settlement

Exposure reduction can most obviously be achieved by having the contractual right to demand some form of security or margin (collateral) as a mitigant against that exposure. A break clause allows a given transaction to be terminated, either mandatorily, optionally, or contingent on some defined event (such as a rating downgrade). Such clauses may apply to one or both parties in a transaction. This chapter discusses several terms associated with margins such as credit support annex, margin call frequency, threshold, initial margin, and the minimum transfer amount. Regulators have started to impose bilateral margin requirements, often known as the uncleared margin requirements, on most major participants when transacting non-centrally-cleared derivatives with one another. Margin also creates some residual risks, such as operational, legal, and liquidity risks. Other potential issues include wrong-way risk, credit risk, and the FX risk.