Variation Margin Haircutting

Variation margin haircutting is a loss-allocation mechanism used by clearinghouses when a default is so severe that it threatens the solvency of the entire system. It involves the proportional reduction of payouts owed to profitable traders to cover the losses incurred by a defaulting member.

Instead of paying out the full daily gain to a trader, the clearinghouse reduces or haircuts the payment to absorb the deficit. This ensures that the clearinghouse remains neutral and avoids bankruptcy, though it shifts the burden of the default onto market participants who were otherwise profitable.

It is considered a tool of last resort, often used when default fund contributions are exhausted.