Reducing the Procyclicality of the Variation Margin in Central Clearing

This study empirically shows that the variation margin (VM) - the daily exchange of profit and loss from derivatives contracts in central clearing - exhibits a high volatility and a close relation to changes in market prices. The magnitude of VM procyclicality is comparable to that of the initial margin and has implications for systemic risk. This study proposes a new scheme called the reciprocal line of credit (RLOC) clause, which is annexed to the main derivatives contract and serves as an internal loan facility between the contract counterparties. Under the RLOC, internal loans can replace VM payments. This study analytically shows that the RLOC can be voluntarily chosen and reduce the systemic risk arising from margin procyclicality