Here’s proof, if more proof was needed, that betting with borrowed money is a bad idea. Within 24 hours of the Swiss central bank’s shock decision to scrap its cap on the value of the franc, a few foreign-exchange brokers have already hit the wall, and others seem likely to follow.
The freewheeling retail FX brokerage industry is founded on leverage—lots of it. Customers can make bets on currencies at a dizzying array of companies with huge amounts of borrowed money, in many cases 100 times or more debt heaped on top of the money they actually deposit with a broker. That means that tiny wiggles in exchange rates can wipe out a trader’s balance, and then some.
The lightly regulated retail FX market sees $400 billion traded every day, and during normal conditions the vast majority of customers lose money on trades. Like casinos, the brokers taking the other side of those trades are the ones who profit, provided that their customers are able to pay their debts.
“If you had no leverage, nobody would trade,” Drew Niv, CEO of broker FXCM told Bloomberg Markets magazine last month. “Currencies don’t move that much.”
Rather, they don’t normally move that much. When the Swiss franc shot up by more than 30% against the euro yesterday, anybody on the wrong side of the trade—or looking to trade at all amid the chaos (paywall)—was wiped out. Brokers that extended generous margin to these customers were left facing big negative balances that are unlikely to be repaid.
The body count
For its part, Niv’s FXCM said its clients suffered “significant” losses, and owed the firm some $225 million. As a result, “the company may be in breach of some regulatory capital requirements.” The company’s New York-listed shares were down by more than 80% in pre-market trading, and halted at the open, pending news.
UK-based Alpari didn’t last the morning, with the currency turmoil pushing it into insolvency. The franc’s “exceptional volatility and extreme lack of liquidity… resulted in the majority of clients sustaining losses which has exceeded their account equity,” it said in a statement. “Where a client cannot cover this loss, it is passed on to us.”
Global Brokers NZ, an Auckland-based trading house, was also forced to shut it doors. The company’s statement reads almost identically to Alapri’s: “The majority of clients in a franc position were on the losing side and sustained losses amounting to far greater than their account equity. When a client cannot cover their losses it is passed onto us.”
Other brokers have been rushing to reassure customers that they can weather the storm. The UK’s IG Group said that it faced losses of up to £30 million ($45.6 million), but touted its “extremely robust financial position.” Its London-listed shares have fallen by around 6% since the Swiss central bank announcement.
Denmark’s Saxo Bank said that it was reviewing trades cleared during the market turmoil and may amend some transactions at “a worse execution rate than the originally filled level.”
By contrast, Oanda of Canada said it would forgive “negative account balances associated with this market event” and took a swipe at its struggling rivals. The Swiss turmoil is “sure to trigger broker consolidation, which as an extremely well capitalized broker, interests us greatly.”
Zurich-based Swissquote said it set aside provisions (pdf) for the losses it sustained, “without affecting the profitability and solidity of the bank.” It was a similar story at UK-based CMC Markets, which “sustained some losses,” its boss said in a statement (pdf), but “the overall impact including possible bad debts has not materially impacted the group.” Other brokers like City Index, ETX Capital, and FXPro issued similarly bullish statements. GAIN Capital claimed that it turned a profit yesterday.
But amid the turmoil, an analyst told Bloomberg that he “would be astonished if we did not see more casualties” in the days the come. Stay tuned.