Why is daily variation margin called 'settled-to-market' instead of 'collateralized-to-market'?

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AcadiFi · Accepted Answer

The distinction is profound for swap valuation. Historically, VM on cleared swaps was treated as collateral posted against exposure (collateralized-to-market, CTM). In 2017, CME and LCH re-characterized VM as actual settlement of the MTM (settled-to-market, STM), eliminating the collateral characterization.

Impact on discounting: Under STM, each day's MTM change is cash-settled and the swap resets to zero value. The swap therefore only has one-day exposure at any time, so the appropriate discount rate is the overnight rate (Fed Funds/SOFR). This is why OIS discounting became standard.

Example: Wensleydale Hedge Fund holds a 10-year cleared swap. At end of Monday, MTM = +$850K vs. Friday's zero. CME credits Wensleydale's margin account $850K cash on Tuesday morning. Swap is now MTM'd to zero; Tuesday's $430K move is separately settled. No ongoing collateral pool.

Accounting: STM swaps show nominal balance of ~$0 on balance sheet rather than a gross derivative asset/liability, cleaning up leverage ratios (SLR) for dealers. Wensleydale's balance sheet footprint shrank 37% after re-characterization per their 2018 audit.

Contrast with uncleared: bilateral CSA swaps remain CTM — margin is pledged, not transferred. Rehypothecation rights differ, and you discount at the CSA rate (usually Fed Funds if USD cash).

Why is daily variation margin called 'settled-to-market' instead of 'collateralized-to-market'?

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