OCC introduced cross margining in 1989 to reduce systemic market risk by recognizing the offsetting value of hedged positions maintained by firms at multiple clearinghouses. By allowing for intermarket hedges, OCC is able to enhance firms’ liquidity and financing capabilities through reduced initial margin requirements, fewer margin variations and smaller net settlements.

Since cross margining’s inception, the number of products eligible for offset has increased significantly. OCC currently participates in cross margin programs with the Chicago Mercantile Exchange and ICE Clear US as well as offering an internal cross margin program for products where OCC clears both the SEC and CFTC regulated contracts.

History

After increased volatility of the late 1980s, advantages of the Cross Margin program became evident. Member firms were experiencing significant liquidity draws as a results of margin calls being issued by one clearinghouse against a position where the member maintained an offsetting position at another clearinghouse.

For example, a clearing member who was synthetically long an index option position while short the futures contract would be required to satisfy a margin call with the options clearinghouse, even though the member maintained an offsetting position with the futures clearinghouse. Despite being hedged, the member would be obligated to meet a cash settlement when, in the aggregate, the overall risk of the position was insensitive to changing prices in the marketplace.

Participation

Cross margining was designed for firms with memberships across various clearing organizations which guarantee products that are highly correlated. Due to differences in securities and futures related customer protection requirements, the program is only open to clearing members and their affiliates, and market professionals who include market makers and futures locals.

In order to facilitate the cross-margin process, participating clearinghouses establish joint clearing accounts for each member. In the event of a default, the clearinghouses’ arrangement provides for the treatment of all assets and obligations associated with the cross-margin account as well as the other clearing accounts of the defaulting member.

Margins

Clearing level margins are computed based on the combined positions maintained in the cross-margin accounts using OCC’s proprietary System for Theoretical Analysis and Numerical Simulations (STANS). STANS is a portfolio-based margin methodology that utilizes a sophisticated options pricing model to identify the economic risk inherent in a portfolio. By combining hedged positions cleared at separate clearinghouses into a single portfolio for margin and settlement purposes, the real risk of that portfolio can be determined. This results in a more appropriate margin requirement, which is typically lower than if margins were calculated separately. The average daily margin savings realized by firms participating in cross margining have been significant.

Operational

Cross margin trades are executed on the exchanges for which the participants clearing organization clear trades and typically are transferred to a joint account via Clearing Member Trade Agreement (CMTA) or give-ups. At the end of each trading day, the futures clearinghouses transmit closing positions and settlement activity to OCC, which in turn calculates clearing level margining and then produces and distributes position, margin and settlement reports to clearing members.

Summary

Cross margining has proven to be a viable tool for participating firms, allowing them to enhance the efficiency and the ability in meeting their financial obligations to the marketplace. This is especially important during periods of increasing market volatility. By recognizing intermarket hedged positions cleared by different clearing organizations, cross margining increases the overall efficiency of the clearing and settlement process, providing reduced initial margin requirements as well as increased liquidity in the form of net settlements.