Market Volatility Leads to Fresh Focus on Machinery Beneath Trading Investors struggle to pivot from calm, rising markets to a period of lurches in asset prices Employees last year at Options Clearing Corp., which operates a clearinghouse.PHOTO:LYNDON FRENCH FOR THE WALL STREET JOURNAL 43COMMENTS By Gunjan Banerjiand Telis Demos Dec. 11, 2018 5:30 a.m. ET Wild trading is straining the plumbing that powers global markets. In November, natural-gas futures surged 18% in one day, the biggest jump in more than a decade, only to plunge nearly 17% the following day. That caused some contracts tied to the fuel to breach central clearinghouse margin limits. Margins in FocusAs volatility picks up, price movements on keyfutures contracts globally are frequentlyexceeding margin thresholds set by centralclearinghouses.Number of breachesSource: JPMorgan Chase 000Jan. ’18MaySept.05101520 And that was just one instance in one market of such breaches. At least 49 times this year, major derivatives contracts globally—including on U.S. Treasurys and the S&P 500—have seen price moves that exceeded margin limits, according to figures compiled by JPMorgan Chase & Co. These breaches essentially mean that the amount of money traders put up to cover potential losses on trades was insufficient, one of several incidents putting a spotlight on how prepared clearinghouses are for the return of volatility. The uncertainty is yet another example of how investors are struggling to pivot from years of calm, gently rising markets to a new period marked by sudden, big lurches in asset prices. Clearinghouses, operated by companies such as Options Clearing Corp. andIntercontinental ExchangeInc.,have become key to postcrisis derivatives markets. If they struggle to handle choppy markets, that could exacerbate already-volatile trading. To counter that possibility, clearinghouses are raising margin requirements and adjusting their models for calculating those requirements. This has its own issues, though. Clients of the clearinghouse members, which include big banks, may shy away from some trades because they become more expensive, and traders may be less willing to invest during periods of stress for fear that costs will suddenly rise. Nick Rustad, JPMorgan’s global head of clearing, noted the sharp spikes in volatility after long periods of calm, as well as other market changes such as more automated trading. “If we believe that market infrastructure has changed in the last 10 years,” Mr. Rustad said, “then the question is whether the margin regime fit for purpose in the past is fit for the future.” Clearinghouses have been around for years, quietly serving as middlemen between buyers and sellers of financial derivatives tied to interest rates, commodities, stocks and more. When two traders, such as a bank and a hedge fund, strike a deal for a derivative that pays out in the future, they ask a clearinghouse to stand in for each party. The clearinghouse collects money from each side, known as margin, that covers the two traders’ payment obligations under most possible market price moves. They also collect money for a default fund that would cover extreme losses, or if one party were unable to pay, using sophisticated mathematical models to calculate these likelihoods. The organizations took on a bigger role after the financial crisis, when investors panicked over whether long-term derivatives contracts with troubled firms would be honored. Afterward, global regulators crafted rules to push banks and their clients to funnel trades through the clearinghouses, as a way to reduce fear that a big bank’s failure would ripple through the markets. The difficulty in calibrating requirements for newly turbulent times brings clearinghouses back into the spotlight. “Maybe the models that we’re employing are not taking into account the black swan events that are becoming more regular over time,” said John O’Hara, New York-based head of prime brokerage and clearing at Société Générale SA. One extreme example: In September, a Norwegian power trader at Nasdaq Inc. defaulted on its obligations, requiring other members of Nasdaq’s clearinghouse to use roughly $122 million from a special fund to cover the shortfall. Advocates say the clearinghouse model has held up, and that it is natural for clearinghouses to make improvements as markets evolve. Clearinghouses also track breaches across their members’ portfolios for a wider look at how much risk they are exposed to, which can blunt the impact of any individual contract that exceeds a margin threshold. “Central clearing works,” Edward Tilly, chief executive officer of exchange operatorCboe Global Markets Inc., said at an October industry conference. “I don’t want to lose sight of that.” Cboe partly owns Options Clearing Corp., or OCC. Clearinghouses have been adjusting. Nasdaq raised its margins after the power trader’s default. ICE updated margin requirements for natural-gas contracts after the November price swings, its disclosures show. ComebackMarket volatility roared back this year. TheCboe Volatility Index has seen single-daymoves of at least 20% a record number oftimes.Source: Dow Jones Market DataNote: 2018 is through Dec. 7 But clearinghouses can also run into trouble if they raise margin requirements too much. When the Cboe Volatility Index, or VIX, recorded its biggest jump ever in February, OCC’s models erroneously demanded a 10-fold increase in margin from some of its clearing members, according to a regulatory filing last month. OCC is seeking regulatory approval to tweak its model. A spokesman for Chicago-based OCC said the company never actually called for the 10-fold jump in required margin. “We have authority and processes in place” to determine changes in margin, depending on the circumstances, he said in an email. Still, that sort of mistake could lead to more price swings, because traders might not step into volatile markets if they fear greater margin calls. CME Groupis working on an update to its own model, though a person familiar with the matter said it has been years in the making and isn’t directly tied to recent volatility. As of October, its biggest portfolio-level breach over the past year was $47 million, a fraction of the overall $133 billion in margin held, a second person familiar with CME said. The firm also increased the size of its default fund in the three months ahead of the February surge in volatility. Regulators say they are watching the issue closely. At a Commodity Futures Trading Commission committee meeting this month, Commissioner Rostin Behnam said in a prepared statement that the agency “is continually confronting the challenge of building and maintaining the appropriate regulatory framework for clearing…that will withstand routine shocks and demonstrate resilience in a crisis.” The Futures Industry Association, which represents banks and other clearinghouse members that are on the hook for losses, last month said clearinghouses should ensure they are putting enough of their own capital at risk. Nasdaq had to put up roughly $8 million, to members’ about $122 million, to cover the Norwegian power trader’s default. Nasdaq subsequently posted an additional, temporary injection of about $20 million. But finding a balance can be challenging. Some argue that if clearinghouses cover a bigger proportion of losses, that could drive too much risk-taking by traders.
If margins keep getting hit due to rogue price fluctuations like what was seen in natural gas prices on Oct, it means margins are going to be raised substantially soon.
That tool from optionseller.com who lost all of his funds money few weeks ago, he was selling options on margin in NG, they got a letter saying he owed another 3 million after being wiped out on a short squeeze
$3m for his fund or for himself? He was wearing a nice watch when he apologised to his investors. I think he is still doing quite well personally.
His clients ow the 35 million to the broker, not 3... Ouch I wonder what is going to be the outcome, surely investors cant be held liable for the degenerates margin trades
They can be held liable indeed. The accounts are held in the client's name. So, be careful how your investment fund structure the investment. CTA managed futures accounts work in this way. Liabilities can be unlimited.