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  • 10.2.5-RISK AND THE RELATION TO TRADE CREDIT-MARGIN CALLS - A POTENTIAL HEDGE LIQUIDITY TRAP

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  • Margin calls - a potential hedge liquidity trap

     
     
    Producers, traders and exporters are increasingly seeking ways and means to hedge price risks. When such hedging is done on a futures exchange, directly or through brokers, then deposits and margin calls are part of the deal. Usually producers and exporters sell futures short to hedge unsold crops and stocks. If futures prices then rise, additional and often substantial margin calls can pose real liquidity problems: there may be insufficient liquid funds available to cover the margin calls, even though the underlying trading position is sound and profitable. If there are heavily geared or leveraged speculative positions in the market, then margin calls by themselves can move the price of futures.

    Hedge positions, and their associated potential margin demands, should therefore also be included in the daily position report, as should any gearing or leverage involved in the futures transaction. The difficulty is of course that margin calls can be neither predicted nor quantified in advance, and in extreme cases a company's liquidity may not be adequate to finance them. Commodity banks understand this and their credit packages will make provision for margin calls to avoid otherwise sound operations being derailed.

    Smaller banks in producing countries cannot always offer similar facilities, unless they act as agents for such commodity banks or other providers of risk management solutions.