Leverage ratios has become a subject which has been reopened by regulatory authorities, especially in the aftermath of the exposure to negative account balances experienced by a number of FX brokerages which resulted from the Swiss National Bank’s removal of the 1.20 peg on EURUSD two months ago.
Very highly leveraged trades are notoriously risky to clients, however a new perspective has been highlighted post January 15, insofar as brokerages offering high leverage can also be at risk.
The latest regulator to show his hand with regard to this is Greg Medcalf, the straight-talking Chairman of the Australian Securities and Investments Commission (ASIC), having stated that Australia is being “picked off by online FX brokers” which are able to operate under ASIC with leverage of up to 1:500, whereas many other Western jurisdictions, including the United States, have long since capped leverage to significantly lower levels.
ASIC has become extremely conservative with regard to its moderation of FX brokerages recently, issuing warnings to clients on the pitfalls of trading retail FX via online platforms, as well as demonstrating reluctance to process license applications for new FX brokerages, whilst other financial services companies gain their licenses from ASIC very quickly.
Last year, ASIC forced Pepperstone to exit the Japanese market due to possession of the incorrect license.
The Sydney Morning Herald reported today that Mr. Medcalf spoke at a parliamentary hearing on Friday last week, stating “We’ve discussed this more globally, and we are being picked off as a jurisdiction that allows very high leverage, 500 to 1.”
“It is an issue that’s been discussed recently at the Council of Financial Regulators” he said.
When asked if participants in the foreign exchange market were sophisticated enough to understand the risk, ASIC Commissioner Cathie Armour said there was an “open issue” whether Australia should take the approach of other countries about limiting the amount of leverage.
In terms of revisiting the leverage issue, this represents a clear trip back to the times during 2012 in which Japan’s financial markets regulatory authority, the Financial Services Agency, reduced leverage to 1:25, which was substantially lower than most large Japanese FX firms were used to operating with. At the time, there was much industry concern as to whether this reduction would blight the vast activity that takes place on the retail FX market in Japan which is home to a vast domestic market, served by domestic companies, many of which provide the highest monthly order flow in the world.
Indeed, despite implementation of such a restriction, trading volume was not adversely affected. On the contrary, volumes soared and firms such as GMO CLICK produced a several-month run of $1 trillion in monthly trading volume during mid-2013, and then all time record volumes for any FX brokerage at the beginning of 2015, topping $1.2 trillion in January.
Australia has for some time been a destination of choice for Western FX firms to establish business, partly because of its highly organized business environment and good quality regulatory oversight, but also due to its close proximity to the all-important Asia Pacific region, and the ability to provide traders from China with high leverage and attractive terms, whilst being based in a highly respected jurisdiction, with very long established trade relationships with nearby Asian countries whose trading population by and large do not display the same adherence to conservative trading practices as Japanese traders.
Hong Kong’s authorities reduced the maximum leverage that brokers can provide, thus ampligfying the drive toward Australia’s FX firms by Far Eastern traders.
Given the high leverage allowed in foreign exchange trading, ASIC’s Ms Armour said Australia was “quite fortunate” that brokers here had been able to operate effectively during the significant shock caused by the de-pegging of the Swiss franc in January.
Photograph: ASIC Chairman Greg Medcalf, courtesy of Rob Homer