“It was the best of times, it was the worst of times.” I doubt if Charles Dickens would have ever traded currencies, but the revolution and chaos that followed the removal of the Swiss Franc peg might have been a bit reminiscent for him, considering the heads that rolled and the carnage in the streets. Perhaps, a few prayers would be more in order for those brokers that quickly bit the dust, overwhelmed by client losses from highly leveraged or automated trades. If we are to learn anything from the risk guillotine’s blade, then Alpari UK and FXCM are examples worthy of further examination.
Both firms have been around for some time. Alpari UK has its roots back in Russia in 1998, but its UK operation was formed in 2004, as part of a global expansion. The company remains private, and Andrey Dashin, one of its original founders, is a name most often associated with the Alpari Group today. FXCM, on the other hand, is a public company with its shares traded on Wall Street. The firm was founded in 1999 in New York and is one of the early developers of retail forex trading. Both brokerage houses have in excess of 200,000 retail customers and participate heavily in the daily forex market, where more than $4.5 trillion in turnover is experienced daily.
Both firms also offer a wide range of trading products and services, not confined purely to foreign exchange, but the damage to each occurred due to the swift appreciation of the Swiss France when the Swiss National Bank (SNB) removed its 1.20-peg to the Euro. Many highly-leveraged positions and automated trades from robots and EAs were caught short when the maelstrom occurred last week. Many brokers halted trading until sanity returned. In some markets, a 40% swing in the “EUR/CHF” currency pair valuation was not uncommon.
The market has since leveled off around parity, but recorded losses have been enormous. Alpari UK announced that it was closing its doors and applying for insolvency. The total amount of loss sustained was not disclosed, but these actions did not directly impact the Alpari Group or its flagship, Alpari RU. FXCM, in line with SEC disclosure requirements, advised investors that it has lost $225 million. It quickly moved to raise $300 million in additional capital, but, as the details of this deal become public, the shares of FXCM continued to fall on the NYSE, as investors await more information.
How did the management team at Alpari UK react to the turmoil?
Private companies, in these situations, tend to act more “close to the vest”, so to speak, withholding many details that might come back to haunt them at a later date. Their initial communication on Friday, following the carnage from the previous day, read as follows:
“The recent move on the Swiss franc caused by the Swiss National Bank’s unexpected policy reversal of capping the Swiss franc against the euro has resulted in exceptional volatility and extreme lack of liquidity. This has resulted in the majority of clients sustaining losses which has exceeded their account equity. Where a client cannot cover this loss, it is passed on to us. This has forced Alpari (UK) Limited to confirm today, 16/01/15, that it has entered into insolvency. Retail client funds continue to be segregated in accordance with FCA rules.”
Over the weekend, there was great speculation as to whether a “White Knight” would step forward to buy the firm. FXCM for a while was even cast as a potential suitor, but both firms quickly denied that discussions were taking place. When Monday rolled around, Alpari UK filed for insolvency, and an administrator was appointed. In their latest release, the firm remains hopeful, as implied by the following words:
“After a weekend spent in urgent discussions with various parties with a view to selling the company, these efforts were ultimately unsuccessful. We have had a number of enquiries from interested parties in relation to the company’s business. We will be speaking with these parties and others over the next few days, and hope to secure a deal to preserve the business and jobs as far as possible.”
Hope may spring eternal, but clients are already demanding that their $99 million in segregated deposits, per FCA rules, be refunded. It will take time to determine the true extent of customer losses, since many liquidity providers are presently re-quoting settlement rates. A back office reconciliation nightmare has ensued. Stay tuned.
How did the management team at FXCM react to the turmoil?
From a loss perspective, FXCM was one of the first brokers to release an actual figure for its losses. Amounts had been ranging from a few million to upwards of £30 Million, but when FXCM announced its figure, it was a shot heard round the world:
“Due to unprecedented volatility in EUR/CHF pair after the Swiss National Bank announcement this morning, clients experienced significant losses, generated negative equity balances owed to FXCM of approximately $225 million. As a result of these debit balances, the company may be in breach of some regulatory capital requirements. We are actively discussing alternatives to return our capital to levels prior to today’s events and discussing the matter with our regulators.”
As their shares on Wall Street plummeted, investors absorbed these losses in depreciated share value. A complete loss value remains to be determined. The $225 million amount may seem exorbitant, but it was reported that Citicorp had lost in excess of $150 million, and that the Everest Capital Global Fund, a hedge fund with $830 million under management, was said to have met its doom, all in one 24-hour period. The Risk Guillotine can be extremely harsh when handing out its judgments.
The 3-day weekend in the U.S. did not help matters, but FXCM did move resolutely to arrange for $300 million in addition capital. When details of the deal began to leak, the market reaction on Tuesday was excruciating, according to this analyst’s quote:
“Shares of foreign-exchange brokerage FXCM cratered nearly 90% to a 52-week low of $1.47 in morning trading Tuesday after the company disclosed the terms of its bailout by Leucadia National. Leucadia can force a sale of FXCM and is entitled to at least 50% of the proceeds beyond payment of a $300 million loan and other fees, FXCM said in a statement late Monday. The annual interest rate on the two-year loan can climb to as much as 17% from the original 10%.”
The “new capital” turned out to be a high-interest 2-year loan with a “forced sale call option”, terms that almost guarantee a future liquidation at some point. Stay tuned.
What will go down as the “Swiss Franc Debacle” can be termed as systemic risk, since its impacts have reverberated throughout the entire forex industry and could not have been confined at its source. Dan Curtin, global investment specialist at JP Morgan Private Bank in Boston, summed it up best, “Most central banks have been really clear about how to telegraph their messages, particularly here in the U.S., so having a bank intentionally surprise caught everybody a little flat footed.”
Brokers, banks, managed funds, and investors have lost millions, due the abrupt action taken by a single central banker. The SNB surely could have pursued a more gradual approach to solving its pressing financial issue. Alpari UK and FXCM are just two examples of how firms scramble during chaos, grabbing for any financial life preserver that is handy. As many have already reported, we may only be seeing the tip of this iceberg. It may take months to unravel its broad-based consequences.
It should also be noted that many central bankers have been warning that their “tea leaves” are suggesting that more “liquidity crunches” are hovering just over the horizon. In recent years, the world of retail forex has had to absorb the crisis in Cyprus, the Russian Ruble collapse, and now the Swiss Franc Debacle. One thing is clear with these types of unpredictable risk. You must ensure that your forex broker really does segregate your deposits away from operating capital in Tier-1 bank accounts in accordance with strict regulatory standards. It also helps to avoid unnecessary constructs that are designed to manipulate market forces, the SNB peg for one.