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Law360, London (June 11, 2020, 1:05 PM BST) -- Increasing margin calls during the first month of the coronavirus crisis in Britain helped to keep derivatives market stable by ensuring that counterparties were indemnified against the risk of a trade falling through, the Bank of England has said.
The central bank said Wednesday that recent market turbulence created by the COVID-19 pandemic has highlighted the importance of parties that buy and sell derivatives using margins, collateral put down to reduce the risk of default if one participant in a transaction fails.
"Overall, margin helped to ensure derivatives markets remained resilient throughout the recent market shock," the BoE said on Wednesday.
Buyers and sellers in a derivatives trade have to post collateral to their counterparties when they enter into a trade, called initial margin. They must do the same when their side of the trade drops in value, known as variation margin.
Large movements and volatility in prices mean that buyers and sellers must put down greater amounts in initial and variation margins. The central bank said that counterparties put down a considerably higher amount of collateral in March, compared with the first two months of the year, when some markets saw their largest price movements in 30 years as they reacted to the pandemic.
"Daily variation margin calls … in derivatives markets in March were around five times the average daily margin calls for January and February," the Bank of England said on Wednesday. "Initial margin ... also increased in March, with the overall increase peaking at 31% compared to the average requirement earlier in 2020.
"This mechanically reflected the market events that had resulted from the COVID-19 shock," the central bank added.
The G-20, an international forum for governors of central banks, proposed the margin requirements after the financial crisis to protect the over-the-counter derivatives market.
The forum pushed for most OTC derivatives to be cleared through central counterparties, or CCPs. The G-20 also proposed tighter rules for OTC derivatives that are not centrally cleared to reduce risks to the market, and called on the Basel Committee and the International Organization of Securities Commissions to develop them.
The European Market Infrastructure Regulation, the bloc's rulebook for derivatives trading, implements the margin rules in the European Union.
--Editing by Ed Harris.
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