ICE’s VAR transition marks a fork in the road for energy markets

In under a month’s time, ICE will complete its transition to a Value-at-Risk (VAR) margin model for all its energy products. While in principle this may seem like a very esoteric change, in practice it signals one of the most important structural shifts in cleared derivatives risk management in recent times.

For decades, Standard Portfolio Analysis of Risk (SPAN) has served the industry well. But as energy markets have become more volatile thanks in large part to an unpredictable geopolitical climate, its limitations have become increasingly evident. SPAN’s framework, built on static scenarios, has struggled to keep pace with today’s rapid shifts in prices. During recent periods of stress, from the pandemic shock to the Russia-Ukraine war, market participants saw margins surge and remain elevated long after volatility receded, keeping trading costs stubbornly high and liquidity unnecessarily constrained.

The move to VAR is, therefore, both overdue and welcome. VAR’s strength lies in its dynamism. It recalibrates daily to current market conditions, reflecting evolving correlations and risk factors across portfolios. This responsiveness means more accurate offsets, more appropriate margin levels, and ultimately, more efficient use of capital. Most market participants are anticipating lower margin requirements once ICE’s model goes live, mirroring the margin efficiencies already seen at CME since its 2023 VAR roll-out.

That said, VAR introduces a new rhythm to market behaviour. Its reactivity means margin calls will rise more sharply during stress events. Equally, though, they will fall faster once markets stabilise. This elasticity should help dampen the protracted liquidity squeeze that often followed major volatility spikes under SPAN, where elevated margins lingered long after the risk had passed.

The implications extend beyond simple cost reduction. Lower clearing costs could help shift more US energy trading from bilateral OTC arrangements onto the exchange. That would deepen on-screen liquidity, enhance transparency, and reinforce the central role of clearing in mitigating systemic risk. For brokers and clearing members, however, the transition is more nuanced. While clients may benefit from reduced margin requirements, brokers could face tighter spreads between collected and posted margin, requiring even more careful risk management.

Collateral flexibility will also be critical. With the industry focused on liquidity efficiency, ICE’s plan to broaden its list of eligible collateral, notably by accepting letters of credit, as CME already does, would be a welcome development. Looking further ahead, the debate around tokenised collateral, from gold to other digitised assets, will only intensify as firms seek faster, more diverse sources of funding.

Ultimately, ICE’s adoption of VAR represents a clearing system that adapts in real-time, aligning margin with actual market risk, rather than lagging behind it. For financial institutions prepared to manage the increased reactivity and funding flexibility this demands, the rewards will lead to improved capital efficiency, lower barriers to exchange trading, and, ultimately, more resilient liquidity.

The transition on November 12 is the next step in a broader re-engineering of energy market structure. If executed well, it could mark the beginning of a more transparent, cost-effective and adaptive era for cleared energy markets.