CME applies haircut and why it doesn’t matter.

The CME Group announced that early Monday they were applying a haircut to bonds.  Lets define haircut and purpose of a bond.

A haircut:

In finance, a haircut is a percentage that is subtracted from the market value of an asset that is being used as collateral. The size of the haircut reflects the perceived risk associated with holding the asset. However, the lender has a lien for the entirety of the asset.

Purpose of bond: 

Performance bonds – deposits required to ensure that a clearing member can cover potential losses with his or her trading positions – help to ensure that clearing members can meet their obligations to their customers and to CME Clearing.

Via Reuters:

An exchange typically raises margin requirements and increases haircuts to discourage excessive risk-taking, in a bid to reduce volatility. Wild market swings tend to discourage trading, which hurts an exchange’s revenue.

The reason the exchanges raises margin is to protect themselves and the FCM’s.  I am of the camp that margin requirements are more correlation than causation.  Most professional traders and/or their FCM’s have appropriate margin.  But it can effects positions and smaller traders.  The exchange loves volatility at least in the short run because volatility equals volume.

What will be significant?  If the prices of memberships start popping, then you know there will be volatility coming.

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