The Margin Call That Was Treated as a Deposit
On Monday a client holds 12 equity index futures contracts, each with a contract value of NZD 125,000 (index 6,250 x NZD 20 multiplier). Initial margin is NZD 8,000 per contract and maintenance margin is NZD 6,500 per contract; the client has NZD 96,000 in the futures account. The clearing participant's client account is segregated. By Tuesday's close the index falls 3.2%. The participant issues a variation margin call for the mark-to-market loss and a further initial margin top-up because the exchange raises margin rates by 15% effective Wednesday. The client wires only half the requested amount and says the adviser told him 'margin is just a deposit and you only lose it if you default'. On Wednesday the index falls another 1.8%; the participant considers closing out the position.
1. Calculate the Tuesday margin position and explain the difference between variation margin and initial margin.
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Total notional is 12 x NZD 125,000 = NZD 1,500,000. A 3.2% fall produces a mark-to-market loss of 1,500,000 x 0.032 = NZD 48,000. Account equity becomes 96,000 - 48,000 = NZD 48,000. Maintenance margin is 12 x 6,500 = NZD 78,000, so equity is NZD 30,000 below maintenance. To restore initial margin at the old rate, the client needs 96,000 - 48,000 = NZD 48,000.
But the exchange raises initial margin by 15%, to 8,000 x 1.15 = NZD 9,200 per contract, or 12 x 9,200 = NZD 110,400. The top-up to the new initial margin is 110,400 - 48,000 = NZD 62,400. Variation margin is the daily cash settlement of the loss; initial margin is a performance bond held against future adverse moves. Paying variation margin does not restore initial margin automatically, and initial margin is not a maximum loss.
2. The client pays only half the requested amount. What should the participant do, and can it close out the position?
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The participant should apply its client agreement and clearing rules. A partial payment leaves the account below the required margin. The participant should notify the client promptly of the shortfall, state the deadline and explain that it may close out enough of the position to restore compliance. It should not wait passively for the market to recover.
Close-out is normally permitted when a margin call is not met, but the participant should act in an orderly way, document the calculation, give any notice required by the agreement, and close only what is needed to bring the account within requirements. It should avoid selling the entire position if a partial close restores margin, unless the agreement or risk conditions justify full liquidation. The client's instruction should be recorded. Any residual loss, fees and close-out costs remain the client's obligation.
3. Critique the adviser's statement that margin is just a deposit and you only lose it if you default.
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The statement is misleading. Margin is a performance bond, not a cap on loss. The client's loss is the daily mark-to-market movement on the full notional; with 12 contracts, a 1.8% further fall costs another 1,500,000 x 0.018 = NZD 27,000. Losses can exceed the initial margin, and the client must fund variation margin even if the position is not closed. Default is not the trigger for loss; adverse price movement is the trigger.
Calling margin a 'deposit' also obscures that the participant holds it as collateral and can close out on a shortfall. The adviser should have explained leverage, daily cash settlement, the possibility of multiple calls in volatile markets, and the risk of forced close-out at the worst time. The file should record that explanation. The statement may also indicate a broader advice-quality issue requiring compliance review.