What a difference a quarter makes.
While the forex trading industry has seen a lot of changes over the past few years – for example major adjustments to regulations, social trading trends, introduction of new products such as binary options… – nothing reshaped the industry quite like the events of January 15, 2015.
On the face of it, what happened early on the morning of Jan 15 doesn’t seem so monumental. After the Swiss National Bank made a brief announcement that it would no longer hold down the value of the Swiss Franc after pursuing a 1.20 floor value for the EURCHF for several years, the Franc instantly appreciated about 20% against most major currencies, essentially going from par with the US Dollar to par with the Euro.
That was it.
However the reverberations of that one move in a currency that is not among the top four traded currencies worldwide had an immediate and drastic impact on the forex sector, and are still being felt today.
The reason? In one word – LEVERAGE.
Forex brokers allow their clients to trade using leverage – a lot of leverage. A client can deposit $1,000, and trade as if he or she has $100,000 (or even more). In that scenario, a 1% move in the right direction and the client can double his or her money. But a 1% move in the wrong direction, and the $1,000 deposit disappears.
So when a sudden 20% move happens, that $1,000 suddenly becomes $20,000 if you’re on the right side of the trade. And many forex brokers did see about half of their clients (who had open CHF pair positions) hit the jackpot with their CHF trades. But the other half were on the wrong side of the market that morning.
So why didn’t things balance out?
Well they did, but only on paper. The ‘losing’ clients only had (as per our simplified example) $1,000 on deposit to cover their sudden $20,000 losses. And the brokers – even those who don’t formally forgive these ‘negative client balances’ – had little to no chance of ever seeing that money.
And the negative client balances piled up at some of the leading retail forex brokers. The biggest of them all, FXCM Inc (NYSE:FXCM), reported a whopping $225 million in negative client balances (which later turned out to be much larger, or about $276 million), which nearly put the firm under until a last-minute $300 million rescue loan from Leucadia. FCA-regulated Alpari UK entered insolvency. As did the smaller LQD Markets, and prime broker Boston Prime.
And those firms which survived (generally) did not escape unscathed, with losses in the tens of millions suffered by other brokers such as IG Group, Saxo Bank and OANDA.
The experience has left the industry somewhat sobered. Many brokers have cut allowed leverage across the board, although other aggressive brokers, sensing an opportunity among still-leverage-hungry clients, are stepping up to fill the leverage void.
Regulators have started to look at leverage again, with entities such as Australia’s ASIC looking seriously at following the lead of Japan’s JFSA (25:1) and the NFA in the US (50:1 for major pairs) and limiting maximum leverage in FX trading.
The backbone of the industry behind the scenes – liquidity providers – are also making changes, requiring a lot more margin to be posted by the brokers they work with. Brokers, in turn, are leaving the big bank LPs in favor of more aggressive relationships with smaller liquidity providers which enable them to post less margin and – in turn – continue to offer higher leverage to clients.
We expect even more industry consolidation in Q2, as the stronger look to acquire the weaker, and as many brokers find it difficult to deal with the new era of lower leverage (at least for a while).
What will Q2 bring? Stay tuned to LeapRate…