In derivatives clearing and collateral management, two distinct types of margin serve different purposes. Variation Margin (VM) reflects daily gains and losses — it keeps the mark-to-market of open positions settled between the parties on a daily basis. Initial Margin (IM) is a pre-funded buffer against the risk that a counterparty defaults before positions can be closed out.
Variation Margin: the daily settlement
Every business day, the mark-to-market of a derivatives portfolio changes. If a position has moved in your favour by £500,000, your counterparty (or the CCP) owes you £500,000 in VM. If it has moved against you by that amount, you owe it. VM payments keep the accumulated mark-to-market settled daily, so that no large unpaid balance builds up over time.
VM is paid in cash and transfers outright — it is not collateral in the traditional sense. The recipient can use it freely. This is why the CCP's VM exposure at any given moment is close to zero: any move since yesterday's close is settled by the overnight VM call.
Initial Margin: the forward-looking buffer
IM is not about yesterday's moves — it is about potential future moves. If a clearing member defaults today, the CCP must close out all their positions over the next several days. Markets will be volatile; prices will move. IM is calculated to cover the potential loss over that close-out period at a high confidence level.
IM must be posted upfront and maintained throughout the life of the trade. It is segregated — held separately from the recipient's own assets — so it is available immediately if the poster defaults. Unlike VM, IM is not consumed by daily moves: it is a standing buffer.
Bilateral IM under UMR
Post-crisis regulatory reform extended the IM requirement to bilateral (uncleared) derivatives above certain notional thresholds, under the Uncleared Margin Rules (UMR). Calculating and managing bilateral IM — using the ISDA SIMM model — and maintaining segregated custodial accounts has been one of the major operational challenges in derivatives markets over the past decade.
How IM is calculated for cleared and bilateral trades, how UMR thresholds work, and how collateral operations manages the daily margin cycle are explored in Market Mechanics — the complete plain-English guide to how a bank's markets business works.