What Is Incremental Margin Call?
An incremental margin call is a demand from a broker-dealer for a client to deposit additional funds or securities into their margin account to meet minimum maintenance margin requirements. This financial term falls under the broader category of risk management in finance, specifically within securities trading and capital markets. It occurs when the value of assets held in a margin account declines, reducing the account's equity below the brokerage firm's required maintenance level. The incremental margin call specifies the additional amount of capital needed to bring the account back into compliance. Failure to meet an incremental margin call can lead to the forced liquidation of positions.
History and Origin
The concept of margin requirements and subsequent margin calls has been integral to securities and commodities trading for over a century, evolving with market complexity and regulatory frameworks. Early forms of leveraged trading existed long before formal regulations. However, the need for standardized margin rules became apparent, particularly after periods of significant market volatility and financial crises. In the United States, the Securities Exchange Act of 1934 granted the Federal Reserve Board authority to regulate the amount of credit that may be initially extended and subsequently maintained on securities. This led to regulations such as Regulation T, which governs credit extended by broker-dealers. The Financial Industry Regulatory Authority (FINRA), as a self-regulatory organization, also plays a crucial role in setting and enforcing margin requirements for its member firms. For instance, FINRA Rule 4210 outlines comprehensive margin requirements for various types of securities transactions, including maintenance margin requirements, which directly underpin the mechanics of an incremental margin call.5
Key Takeaways
- An incremental margin call requires a trader to deposit additional funds or collateral into their margin account.
- It is triggered when the account's equity falls below the established maintenance margin requirement.
- The primary purpose is to ensure that the account holder maintains sufficient collateral to cover potential losses on their leveraged positions.
- Failure to satisfy an incremental margin call can result in the forced sale of assets in the account.
- This mechanism is a critical component of risk management for both the individual trader and the broker-dealer.
Formula and Calculation
An incremental margin call is not a standalone formula but rather the result of a calculation designed to restore an account's equity to a compliant level. It represents the difference between the current account equity and the required maintenance margin, plus potentially a buffer to bring the account back to the initial margin level, or at least above the maintenance level.
The core calculation involves:
- Current Market Value (CMV) of Margined Securities: The total value of all securities held in the margin account.
- Maintenance Margin Percentage (MM%): The minimum percentage of the CMV that must be maintained as equity in the account. This is typically set by the brokerage firm, often above regulatory minimums (e.g., FINRA's 25% for equity securities).4
- Account Equity (AE): The current market value of margined securities minus the debit balance (borrowed funds).
The Maintenance Margin Requirement (MMR) is calculated as:
An incremental margin call is triggered when (AE < MMR). The amount of the Incremental Margin Call (IMC) often seeks to restore the account to at least the MMR, or sometimes to the initial margin level, depending on the broker's policy.
Alternatively, some brokers may require bringing the account back to the initial margin level, which is typically higher than the maintenance margin. In such a case, if Initial Margin Requirement (IMR) is the target, then:
The specific amount required in an incremental margin call will depend on the brokerage's internal policies and the severity of the equity shortfall.
Interpreting the Incremental Margin Call
Receiving an incremental margin call signals that the leveraged trading positions in a margin account have depreciated significantly, reducing the available equity below the required threshold. From a trader's perspective, it indicates increased financial risk and the urgent need to either inject more capital or reduce exposure. Ignoring an incremental margin call can lead to forced selling of positions by the broker-dealer, often at unfavorable prices, to cover the shortfall. This process, known as liquidation, can lead to substantial losses beyond the initial decline in asset value. For brokerages, the incremental margin call mechanism is a critical risk management tool, protecting them from client defaults and ensuring compliance with regulatory capital requirements.
Hypothetical Example
Consider an investor, Sarah, who uses her margin account to purchase 1,000 shares of XYZ Corp. at $50 per share, totaling $50,000. Her broker requires an initial margin of 50%, so Sarah uses $25,000 of her own cash and borrows $25,000 from the broker. The maintenance margin requirement is 30% of the current market value.
Initial State:
- Total Value of Securities (CMV): $50,000
- Debit Balance: $25,000
- Account Equity (AE): $50,000 - $25,000 = $25,000
- Maintenance Margin Requirement (MMR): $50,000 * 30% = $15,000
Now, imagine XYZ Corp.'s stock price falls to $35 per share.
New State:
- Total Value of Securities (CMV): 1,000 shares * $35/share = $35,000
- Debit Balance (remains): $25,000
- Account Equity (AE): $35,000 - $25,000 = $10,000
At this point, Sarah's account equity ($10,000) is below the maintenance margin requirement ($15,000). The broker issues an incremental margin call.
Incremental Margin Call Calculation:
- Required Equity to meet MMR: $15,000
- Current Equity: $10,000
- Incremental Margin Call: $15,000 - $10,000 = $5,000
Sarah must deposit an additional $5,000 into her account to meet the incremental margin call and avoid liquidation of her positions. This example highlights how a decline in the value of securities can quickly trigger such a call when trading with leverage.
Practical Applications
Incremental margin calls are a routine occurrence in various segments of the financial markets where leveraged trading is prevalent. They are commonly encountered by individual investors trading equities, as well as by institutional participants in more complex markets such as futures contracts, derivatives, and short selling. Clearinghouses and exchanges, like the CME Group, establish specific margin requirements for futures and options to ensure market integrity and manage counterparty risk. These requirements, often referred to as performance bonds, are calculated daily and can be adjusted based on market volatility and risk assessments.3,2 When the value of positions fluctuates, leading to insufficient collateral, an incremental margin call will be issued to restore the necessary funds. This mechanism helps to stabilize markets by preventing excessive losses from cascading through the system and impacting multiple participants.
Limitations and Criticisms
While incremental margin calls are a vital component of financial risk management, they are not without limitations and can face criticism, particularly during periods of extreme market volatility. One major criticism is the procyclical nature of margin calls: they tend to intensify selling pressure during market downturns, as investors are forced to liquidate positions to meet the calls, further exacerbating price declines. This can create a vicious cycle, especially for highly leveraged accounts. Additionally, the speed with which an incremental margin call must be met can be challenging, particularly for large or illiquid positions, potentially leading to forced sales at disadvantageous prices.
A high-profile example of the severe consequences of unmet margin calls was the collapse of Archegos Capital Management in March 2021. Archegos, a family office, had accumulated highly leveraged positions in certain stocks through total return swaps, an equity derivative. When the prices of these underlying stocks declined sharply, prime brokers issued substantial margin calls that Archegos was unable to meet. This failure led to a massive, rapid sell-off of billions of dollars worth of securities by the banks involved, resulting in billions in losses for major financial institutions.1 The incident highlighted how opaque, highly leveraged positions can pose systemic risks if margin calls are not met, even with robust collateral requirements in place.
Incremental Margin Call vs. Maintenance Margin Call
The terms "incremental margin call" and "maintenance margin call" are often used interchangeably, but it's important to understand their precise relationship. A maintenance margin call is the event or notification itself—a broker's demand for additional funds when the equity in a margin account falls below the minimum required maintenance level. The incremental margin call specifically refers to the amount of additional capital or collateral that is being requested to bring the account back into compliance. Essentially, an incremental margin call quantifies the deficiency identified by a maintenance margin call. The maintenance margin is the threshold that, once breached, triggers the call for an incremental amount of funds.
FAQs
What happens if I don't meet an incremental margin call?
If you fail to meet an incremental margin call by the deadline specified by your broker-dealer, the brokerage firm has the right, and often the obligation, to sell some or all of your securities held in the margin account. This forced sale, known as liquidation, is done to cover the margin deficiency and can occur without prior notice, potentially at unfavorable market prices, leading to significant losses.
Can an incremental margin call be larger than my initial investment?
Yes, in some cases, especially with highly leveraged trading or volatile markets, the amount of an incremental margin call can exceed your initial cash outlay. This is because you are trading with borrowed money, and if the value of your positions declines significantly, your losses can quickly erase your equity and extend beyond your initial investment.
How quickly do I need to respond to an incremental margin call?
The response time for an incremental margin call is typically very short, often within a few business days, or even by the end of the same trading day, depending on the brokerage firm's policy and market conditions. For futures or options contracts, the deadlines can be even tighter due to higher volatility and daily mark-to-market settlements.
Does an incremental margin call only apply to stocks?
No, while commonly associated with stock trading on margin, incremental margin calls apply to any financial instrument that can be traded on margin. This includes futures contracts, options, derivatives, and certain fixed-income securities, as long as they involve borrowed funds or leverage. The specific margin requirements vary greatly by asset class and exchange.
What are some ways to meet an incremental margin call?
You can meet an incremental margin call by depositing additional cash into your margin account or by depositing other marginable securities that meet the brokerage's collateral requirements. Alternatively, you can close out some of your existing positions to reduce your debit balance and bring your equity back above the maintenance margin threshold.