Consequences of ‘Black Thursday’ for the FX market by Milan Cutkovic

Thursday was the day the SNB shocked the markets and abandoned the 1.20 floor in EUR/CHF. While it was clear that the bank’s job would have got increasingly difficult with QE in the Euro-Area just around the corner, barely anyone expected that the SNB would make such a decision, especially that early. The decision itself is disputed in Switzerland. Corporate Switzerland is shocked of course and very pessimistic now that EUR/CHF is trading at parity. Exports and the tourism branch are threatened the most. Swiss consumers living near the border have already rushed to their neighbouring EU country to do their shopping and for those who don’t find this convinient, there is always the option of online shopping. Many items can still be bought cheaper online than in Switzerland, even after shipping and taxes. Overall, the sentiment amongst the fellow Swiss citiziens I talked to was mostly positive. While those working in a company that depends on export or tourism have expressed concerns, many were happy about the sudden increase in purchasing power abroad and think that Corporate Switzerland will be able to cope with the CHF strength.

The sentiment amongst retail FX traders wasn’t that cheery. A large number of traders saw their account completely wiped out by the massive drop in EUR/CHF and some had negative balances, meaning technically, they would be owing the broker money. Whether they actually owe the brokers any money, depends on the broker. Some clearly state in their Terms & Conditions that you cannot lose more than you deposited, so that in the unlikely event the NAV (net asset value) turns negative, it is up to the broker to cover the losses. However, some brokers state that your losses can exceed your deposit and it remains to be seen if there will be a broker going after their clients due to negative account balances.

Even traders that did not have any CHF positions that day probably got worried if they broker will make it through this. One New Zealand-based broker, Excel Markets, had to close their business due to failure to meet the regulatory minimum capitalization requirements after the EUR/CHF carnage. FXCM said clients owe them $225 million in negative balances and it had to be bailed out by US-based Leucadia. Alpari UK announced its insolvency and IG Markets suffered a loss of around $45 million. All in all, it was a terrible day for most brokers and retail traders.

So, what are the possible consequences for the retail FX industry after this event?

I. Consolidation amongst FX brokerages

Some brokers already announced that they are looking at possible acquisitions, with GAIN Capital who operates the platform, the most notable. GAIN announced that the SNB event did not hurt the company and that they actually made a profit on that day. Further, they showed strength by expressing their interest in acquiring other brokerages. There are likely more small NDD/STP brokers that have been hurt significantly and will make attractive targets in the near-term. I see GAIN and OANDA benefiting the most from this. GAIN mostly for the above mentioned reasons and OANDA for the fact that they honored all their clients prices and didn’t revise them afterwards, as some brokers did. This has boosted their reputation massively and shouldn’t be underestimated, especially now as many retail traders are looking to switch brokers. FXCM will be the biggest loser as a fair number of clients are probably already making larger withdrawals from their accounts or plan to close it altogether. FXCM is the largest FX retail broker in the world and many clients were surprised how weak their risk management has been. Most of FXCM’s customers are probably still feeling uncomfortable, even after the bailout, and they will have a difficult time obtaining new clients in the near-term. Overall, I expect further consolidation amongst FX brokerages.

II. The retail market will come under greater scrutiny

A couple of years ago, the CFTC already had plans to lower leverage for US-based retail traders to 10:1, but lobbying from brokerages prevented this and it was only lowered to 50:1. The retail market will receive again greater attention from regulators after the Black Thursday and I wouldn’t be surprised if the US regulatory agencies will be again pushing for much higher margin requirements. This time, brokers will have a tough time defending their position and the number of active FX brokers in the States has decreased significantly since 2010 as well. European regulators are likely to take notice as well. While I don’t think that the EU regulators will limit leverage for traders (or at least not significantly, in the case it does), it is highly likely that capital requirements for brokers will increase and that the regulators will try to highlight again the high risk that FX trading can carry. The media has been already portraying the FX market as the “Wild West” for retail traders & FX trading akin to gambling and I’m afraid that this will only increase. Obviously, having the option to use 200:1 leverage doesn’t mean you have to do that, but the fact that it depends on the trader how risky his trading will be doesn’t matter to them.

III. Will currencies eventually be exchanged-traded?

A fair number of electronic trading venues have appeared in the past few years and this trend is likely to continue in the near-term. While electronic trading in FX is mostly the norm nowadays, some think FX should eventually move to a market structure where it would be traded similar to equities. A transparent exchange where a retail trader from home could get the same price as some institutional trader sitting in his fancy office. While I think that this idea could gain momentum after the SNB event, it will likely take several years more before we will see any significant development in the core market structure.

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