NZX Derivatives Adviser: Margin, Clearing and Settlement

Central clearing

NZX Clearing acts as central counterparty, standing between buyer and seller through novation. This reduces bilateral counterparty risk but concentrates default management in the clearing house. Clearing includes netting, margining, collateral management and a default waterfall. Participants must meet membership, capital and operational requirements.

Margin mechanics

Initial margin is collateral posted to cover potential future exposure. Variation margin settles the daily mark-to-market gain or loss. Margin is not a fee and is not a down payment; it is performance assurance. Collateral may be cash or eligible securities, subject to haircuts and concentration limits. Intraday margin calls can occur in volatile markets, and failure to meet a call can lead to close-out.

Settlement and client money

At expiry, cash settlement transfers the final gain or loss. Client money must be segregated from the firm's own money and reconciled. Records must show each client's positions, collateral and transactions. The exam tests the chain: trade, novation, margin, settlement, default.

Worked example

A client posts NZ$50,000 initial margin. A market move creates a NZ$12,000 loss, so variation margin is due. If the client does not pay, the participant may close the position and apply the collateral. The reasoning is that initial margin is a buffer, while variation margin settles the actual loss.

Traps

Calling margin a fee; thinking initial margin covers the day's loss; using client money to meet a firm margin call; and ignoring intraday calls and haircuts.