• QA 197
    Why have the margin requirements for New York arabica coffee futures been raised? Will this have any influence on price fluctuations?
    We note that ICE (the New York futures market) has raised the margins payable on open contracts. Why? Any influence on price fluctuations?
    Asked by:
    Exporter/trader - Burundi

    Margins represent a percentage of the average value of certain benchmark trading positions over a given period. When futures prices change materially over time then margin requirements will be adjusted to reflect this. *

    On July 3rd 2008 the New York arabica contract initiating margins were increased as follows:

             Hedgers from USD 2,500 to USD 3,000 per contract
             Speculators from USD 3,500 to USD 4,200 per contract

    Records show that on 2 July 2007 the second New York position was quoted at 112 cts/lb whereas on 2 July 2008 the quotation was 159 cts/lb - this represents a material price change therefore and we assume this caused the committee that determines margin levels to act.

    Whether or not this will influence price volatility remains to be seen but it seems unlikely. We say this because large speculative interests as index funds for example (see Q&A 193 in the Q&A Archive) usually do not lack the funds to put up margins. For normal trade hedgers this of course represent an increase in the cost of doing business but, the futures exchange has to maintain its financial integrity in the interests of all. As the figures above show, speculators are required to pay higher initial margins.

    This raises an interesting question. How does the exchange differentiate between the two groups: hedgers and speculators?

    Clearing House members (see topic 08.02.01) are obliged to provide extensive background information on the clients or entities that buy and sell futures. This is done to determine in which category the orders in question will be rated. Hedgers must be able to prove that they have a direct involvement with the physical product. For example they are importers, dealers or roasters and handle physical coffee. All others are considered to be speculators and are charged initial margins accordingly.  Variation margins on the other hand are a consequence of market activity after a position has been initiated - prices fluctuate. They are therefore not differentiated between hedgers and speculators. **

    * Original or initial margins are the minimum deposit that the Clearing House demands from participants and are paid through the brokers when a contract is initiated (entered into). Individual brokers and futures traders may however demand higher margins from their clients, depending on their assessment of each client's financial standing. Initial margins are paid when a contract is initiated (entered into). If and when the price subsequently moves against the contract holder then variation margins must be paid to maintain the security provided by the initial margin. Margins are part of the financial security system that enables the Clearing House to guarantee that all contracts will be honoured, always.

    ** Futures Markets and Hedging are discussed extensively in Chapters 8 and 9 of the Guide. The Q&A Archive also contains a number of answers on a variety of issues related to futures trading. Most easily retrieved by selecting 'Sorted by chapter' from the Q&A Archive options.

    Posted 25 July 2008

    Related chapter(s):
    Related Q & A:
    Q&A 051, 193