Maintenance Margin
Movements in the daily price are reflected in the flow of Variation Margin between the margin accounts of the Protection Buyer and the Protection Seller.
The clearing system ensures that the parties always have sufficient funds in their margin account to meet their potential financial obligations. This is the function of Maintenance Margin which is, in effect, a security deposit.
Maintenance Margin can be made by deposits of cash, or high grade interest bearing securities, letters of credit or accumulation of Variation Margin.
It is important to note that just like a conventional (re)insurance policy;
1) At no time will the Protection Buyer ever have to commit more funds than the
initial contract price.
2) At no time will the Protection Seller ever have to commit more funds than the
difference between the contract limit/notional value and the initial contract price.
The Maintenance Margin currently required by the Clearing Corporation is as follows. Some Clearing Members may require more.
* or that sum determined by the daily price if that is different. The Protection Buyer never has to commit
more than that implied by the initial contract price. The Protection Seller never has to commit more
than the amount implied by the difference between the contract limit/notional value and the initial
contract price.
What is the role of the margining process? It helps to eliminate counterparty risk;
Consider a situation where a ‘severe threat’ has been declared and there has been a steep upward movement in daily price resulting in an inflow of Variation Margin from the Protection Seller to the Protection Buyer.
The Protection Buyer’s margin account will suffice to meet the Maintenance Margin requirement once he has paid the equivalent of the initial contract price.
If a hurricane then failed to make landfall or the loss is below the chosen Loss Trigger Level (LTL), the daily price will drop with the result that the Protection Buyer will have to repay Variation Margin to the Protection Seller. Because there are automatically sufficient funds in the Protection Buyers margin account to permit such repayment, this possible obligation can be met.