Market volatility in the aftermath of the Russian invasion of Ukraine and an increase in interest rate expectations came together in the first quarter to trigger a flurry of margin breaches across Eurex Clearing’s fixed income and interest rate swaps clearing divisions.

At the central counterparty’s fixed income clearing unit, the number of backtesting breaches – calculated as the occurrences over a rolling 12-month period when margin coverage held against any account fell below the actual marked-to-market exposure of that member account – stood at 409, up from 62 reported in Q4 2021.

The peak breach was €706 million in size, the biggest since public disclosures began in 2015. The average breach size was €11 million, also the highest level on record.

The unit’s achieved coverage level – a measure of how good its margin model is at estimating its mark-to-market exposure – was 99.44%, down from 99.91% three months prior, but higher than the model’s confidence level of 99%. The number of backtesting observations for the quarter stood at 72,394.

At the IRS division, the number of breaches reported at the end of Q1 totalled 447, up from 105 the previous quarter. The peak breach was €214 million in size, the second largest amount since a €246 million breach first reported in Q1 2020. The average breach size was €2.3 million, up from €2.1 million in the last quarter of 2021.

The achieved coverage level fell from 99.88% to 99.54%, but remained above the 99.5% target. Over the quarter, the number of backtesting observations was 97,179.

Total initial margin (IM) held by the fixed income’s default fund, for client and house accounts combined, was €13.4 billion at end-March, up 38% on end-2021.

The fund for IRS trades rose 32% over the same period, to €31.1 billion.

Over the three months to end-March, the maximum aggregate IM call at the CCP was €8.5 billion.

### What is it?

A margin breach occurs when the collateral in a clearing member’s account falls short of the amount needed to cover its marked-to-market exposure. This implies the clearing member has not posted enough cash and securities to the central counterparty to make up for any losses in the event of its collapse. If a breach isn’t covered quickly by a clearing member, it risks being labelled as in default.

Clearing houses subscribing to disclosure rules set by international standard-setters the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions must disclose quarterly the number of times in the past 12 months these shortfalls occur.

They must also report the average and peak size of these uncovered exposures.

At Eurex, the number and size of margin breaches is derived from a backtesting approach for margins that only takes into account the market risk component of the positions and excludes any add-ons for liquidity and concentration risk. The internal backtesting analysis is assessed against a two-day profit & loss margin period of risk, as prescribed by the European Market Infrastructure Regulation for exchange-traded derivatives products.

### Why it matters

The spike in the number and size of breaches is easily explained given what happened in the fixed income and IRS markets in the first quarter.

Following the invasion of Ukraine, investors entered into a full flight-to-safety mode. The spike in the occurrence of margin breaches in fixed income markets came as a result of losses on short positions in German, Italian and French government bond futures, Eurex told Risk Quantum.

On the IRS front, as volatility in interest rates took centre stage, Eurex saw a spike in outstanding notionals for its over-the-counter clearing business, which in turn produced higher IM requirements. With larger volumes of activity going through the CCP, a rise in margin breaches is to be expected.

However, it’s important to point out a number of key technical aspects.

First, no defaults occurred at either clearing divisions. This means clearing members all answered margin calls when asked.

Second, the backtesting model used by Eurex performed as expected, with the coverage level for both fixed income and IRS trades higher than their respective targets.

Lastly, the data disclosed in the CPMI-Iosco disclosures exclude any liquidity adjustments Eurex might ask from its participants. All things equal, had these margin add-ons been included in the backtesting analysis, the peak margin at the fixed income division would have dropped from €706 million to €251 million. Similarly, at the IRS OTC unit, the largest breach would have been €117 million in size versus the €214 million reported.

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