Alpari Bankrupted Brokers Challenged by Swiss Franc

01/19/2015 9:00 am EST

Focus: FOREX

Adam Lemon, of DailyForex.com, outlines the impact last Thursday's surprise announcement from the Swiss National Bank and the rise in the value of the Swiss franc against other currencies had, not just on forex traders, but also on the forex brokerage houses themselves.

Following Thursday's sudden and explosive rise in the value of the Swiss franc against other currencies, there has been mounting concern over the impact this move will have had upon the balance sheets and regulatory positions of forex brokerages, as Alpari (UK) files for bankruptcy and a slew of other forex brokerages release statements.

Following the announcement last Thursday by the Swiss National Bank that it would abandon its effective cap on the value of the Swiss franc, it became effectively impossible for several minutes to enter or exit any CHF trade, even for professional dealers. All retail forex brokerages suspended trading in the CHF. When the CHF came back online, it had shifted in value by approximately 14%, slipping all traders short CHF without guaranteed stops by up to 14% multiplied by their account leverage. Note that leverage from 50 to 200 to 1 is common in retail forex dealing. Alpari (UK) publicly confirmed that the majority of their clients affected negatively by the CHF move had their account balances completely wiped out. Alpari have, however, made it clear the clients with positive account balances are fully segregated and will have their funds returned to them.

At the time of writing, Alpari is the only brokerage to have declared bankruptcy, giving cause for optimism that the industry will largely be able to weather the shock intact. (FXCM) have announced that the CHF move generated negative equity balances, i.e. client monies owed to FXCM not covered by depositors, of approximately $225 million. As a result, the company believes it may be in breach of some regulatory capital requirements and has stated it is actively discussing the matter with regulators with a view to returning their capital to a pre-shock level.

IronFX Global Limited announced they were not affected by the events due to their strong risk management systems. ThinkForex announced "a strong financial position and business as usual". FxPro released a statement affirming that negative balances have not affected client funds and that the company remains fully operational and solidly capitalized.

A Spotlight Behind the Curtain
These events can be expected to shine a spotlight on the inner workings of the retail forex industry and of the real extent of the black swan risk faced by even relatively conservative retail forex traders. These are two issues that many would prefer not to discuss and the events may invite regulatory pressure.

Most retail forex brokerages do not cover or even partially hedge their client's trades, meaning that they are effectively always the opposite of their client's net positions. Under normal market conditions, with most retail clients generating net trading losses, this is a profitable business model. However, with generous margin requirements and enormous leverage, the model means that having even relatively few clients long CHF without any pending take profit orders, could cause serious net damage to a brokerage's net financial position.

Those forex brokerages that do hedge their client's trades, such as FXCM, can still suffer serious losses from this type of price shock, as they offer their clients facilities that FXCM themselves cannot duplicate in their hedging within the inter-bank market, such as guaranteed stops. The essential problem leaving forex brokerages vulnerable to excessive price shocks is the generous margin they offer, as it means that they must pay their winning clients in full, but may find their losing clients have not been required to deposit enough equity in the account to pay for the entire losses their positions have in fact incurred.

It is very unlikely that we are going to see forex brokerages suing their thousands of losing retail clients for the balances, so we can expect brokers to swallow the losses and tighten their belts where necessary.

By Adam Lemon, Contributor, DailyForex.com

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