Margin Maintenance/Mark to Market
During the life cycle of a repo, the market value of the collateral can be maintained by margin maintenance (or mark to market). This means that if the market value falls, the buyer calls for extra collateral of similar credit quality or a cash refund; if the market value of the collateral rises, the seller calls for extra cash or collateral back. It is worth noting that margin maintenance is explicitly agreed to at the start of the trade, or implied by the initial haircut in the absence of explicit agreement.
EXAMPLE: If a dealer reverses in $100 million in securities for one month when their price is 100, it has an outflow of $100 million. If two weeks later, the market value of the securities has declined to $95 million, the dealer is exposed by $5 million in the event of counterparty default. However, if a signed repo or lending agreement is in place, the dealer is entitled to mark the transaction to market. The customer must deliver $5 million cash or eligible collateral worth $5 million in order to reduce the credit exposure back to zero. The reverse, of course, is also true. If the bond price moves to $105 million, the customer could mark the dealer. This facility is essential when the two counterparties have large amounts outstanding with one another, particularly when longer-term trades are involved. Hence margin maintenance on a repo documented under the same agreement, are paid net.
Margin calls can be limited to material changes in net exposure. In other words, it only comes into action when the difference in market values is in excess of an agreed amount. This is called the margin maintenance limit, also known as the minimum transfer amount.
