Right, some big changes are afoot, and I’m going to do my best to make sense of this for you.
It’s coming out of the woodwork that a number of retail brokers are going bust due to losses from being on the wrong side of the announcement by the Swiss National Bank (SNB) that they would no longer defend their currency peg against the Euro. First a bit of background.
The SNB had pegged its currency to the euro at a rate of 1.20. They had promised to defend this peg at all costs, but yesterday they announced that they were no longer going to maintain the peg. I am sure no one imagined the impact this announcement would have. We immediately saw a drop of 46% on the EURCHF as well as large moves on other CHF pairs.
There are much better analysts than me who will get into the details of why this happened, but needless to say lots of people saw the peg as “free money”, and had highly leveraged trades buying EURCHF or selling EURCHF put options to earn the premium.
Because of the magnitude of the move, and the size of these leveraged bets, a lot of people lost more money than then they had in their accounts (if this was you I am truly sorry). This meant that brokers like IG markets lost 30 million GBP and FXCM ended up 225 million in negative balances in it’s clients’ accounts. To put this in context, FXCM is valued at $1 Billion and made $66 million in profit up to Q3 last year. The losses are huge and, in FXCM’s case, will likely require some sort of bail-out/fire sale.
You may think that client losses are not IG or FXCM’s problem, but they are. They need to cover margin with their counter-parties while they wait for clients to top up accounts, and there will be defaults. In the case of FXCM, they cover all clients’ losses for them, so would seem to be 100% liable. Note these terms from their website:
“FXCM will not hold traders responsible for deficit balances [when accounts lose money due to market losses], but clients should be cognizant that all funds on deposit in an account are subject to loss”.
That debt is taken on by FXCM, and not by their clients. With IG it may be the case too, as they offer optional guaranteed stops (at extra cost to the trader). Guaranteed stops fill the clients stop even if the market does not trade there. I am not sure if they were offering these on the EURCHF, but needless to say they are holding a big loss.
Before we continue, it’s important to note that not all brokers are in serious trouble. Some, like Oanda, offset most of their risk. Others like AxiTrader and Pepperstone, according to this article limited the leverage available to clients to 20:1 on the EUR/CHF (but not the USDCHF, which the article fails to point out). Other brokers like Global Prime (who according to the GM have less the 50K in negative balances) limit the leverage on large account balances.
If one or two big players get into trouble, well… it’s not good, but it’s hardly industry changing. Where we are really seeing blood on the streets is amongst the small and medium sized brokers.
It is incredibly easy (read: far too easy) to set-up a Forex brokerage. With the proliferation of Metatrader 4 and the shallow capital requirement, any man and his dog has been able to open a Forex Firm. This is fine in the good times, but what it means is (I suspect) a large number of brokers will have suffered losses beyond their capacity to absorb.
Some early victims includes Alpari (one of the bigger UK brokers) and Excel market based on New Zealand. My industry contacts also tell me that there have been a lot of brokers making calls, seeking to be acquired, so this could be the tip of the iceberg.
What this will all lead to is a large consolidation within the industry. Firstly, a number of brokers will either go bust or be gobbled up by the more solvent players. Secondly, the regulators will jump on the bandwagon, and change capital requirements, making it much harder to open a Forex brokerage, and forcing a number of the less capitalised ones to close. In short, we could see only the large, well-capitalized firm, and/or those that manage their risk very well survive.
I also suspect that margin requirements will be raised. No more 400:1 leverage. We could even see a situation like in Japan, where leverage is limited to 20:1. Expect a change here.
Finally, I think we could see some changes, or a broader enforcement, of the rules that prevent client money being used as margin on positions, along with a greater requirement for segregated accounts.
One of the problems (and I may be wrong here – I am not an expert) is that for many brokers all clients funds are lumped into one account. If the account suffers losses, then those losses will be on the account as a whole.
For example say five people fund their trading accounts with $10,000. The broker will add those deposits all into the one account, say “Broker A Segregated Account” which will then have a balance of $50,000. This account is separate from the account that the broker uses to operate their business (as it should be).
Now imagine that one of the traders has a position on the EURCHF and lost $30,000. The segregated account will now have a balance of $20,000. This means that if the four traders who did not lose money want to withdraw their $10,000 each, there is not enough money to pay them.
In theory, the broker will top the account up and allow the traders to withdraw the funds while they contact the trader with the negative balance to pay up. This is okay if you only have a small negative balance in the account – the broker can handle it. But if it’s 225 million… well, you get the picture.
This is the reason why brokers are required to have a certain amount of capital reserves, or why some brokers don’t use client money for margin (I believe IG does not). Note that this example is simplistic and it would also depend on how the trades are hedged, and what rates trades are executed at.
I suspect we will see some major changes in this type of segregated account too.
What does this mean for you? It may be prudent to withdraw funds from any broker that you are uncertain about, and wait for the dust to settle. Once it does, hopefully we will see a much better regulated and capitalized industry.
Update: Since I wrote this article FX Crunch have released a list of updates from about 50 brokers. Check you your broker has to say. If you have any suspicions at all, at least test withdrawing some funds.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders. He is a part owner of Forex Signal Provider fxrenew.com (You can get a free trial). If you like Sam’s writing you can subscribe to his newsletter for free.
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