Analysis: Brexit – Feel Free to Panic but Not Too Much

Another day has passed where passions around Brexit have been taking their toll on markets, but should brokers worry?

With less than ten calendar days separating the foreign exchange industry and the Brexit referendum in the United Kingdom, the industry and traders are on their toes. The outcome is likely to have a profound impact on the markets and it is time to have yet another look at the status quo and outline the the good, the bad and the ugly aspects of Brexit in the coming weeks.

British citizens are no longer allowed to register for the vote with the deadline expiring last week and at this point in time the outcome of the vote hinges on the preferences of the voters, who have been heavily affected by a variety of opinions and factors recently.

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implied one month volatility of the British pound has almost reached its all time highs of 30 per cent

Last week we saw a number of debates among leading politicians, media endorsements, documentaries and some rather shocking polls for the remain campaign. With the referendum approaching, Betfair’s implied probability of a Brexit jumped from a low of 17.9 per cent a month before the key date to above 40 per cent as of writing.

The implied one month volatility of the British pound has almost reached its all time highs of 30 per cent seen only at the highs of the great financial crisis of 2008.

Ultimately all of the factors mentioned above will affect the foreign exchange and CFDs brokerage industry, but very few if anyone knows with certainty how. In the following lines we will attempt to shed some light on some grey areas and assess what the main risks are for companies in and outside of the European Union. Let’s delve into the good, the bad and the ugly.

The Good – FCA Regulation

A number of critics of the European Union in the United Kingdom have cried out against the regulatory constraints which common authorities for the block are imposing on businesses. The financial industry is undoubtedly one of the key areas of business for the U.K., and hence one of the industries that could be affected the most.

A number of brokers have been regulated by the Financial Conduct Authority and have invested heavily into complying with the stringent requirements outlined by the watchdog. So one of the aspects of the issues affecting the foreign exchange market is, will a Brexit put those efforts at risk?

The most truthful answer to this question right now with or without a Brexit is no, not at all. And one further elaboration: on the contrary.

The FCA has proven and established itself as the most trustworthy regulator in Europe

The Financial Conduct Authority (FCA) has proven and established itself as the most trustworthy regulator in Europe, and probably around the globe. Suffice it to say that a number of companies that are not that strong in Europe are keen to get licensed by the FCA merely for the prestige that the stamp of the London headquartered regulator brings to the brands that have been licensed.

Even in the case of the United Kingdom leaving the European Union, the reputation of the FCA is unlikely to suffer, if not quite the contrary – the U.K. regulator will remain the most trustworthy in Europe and one that has committed substantial resources to establishing a diligent framework for retail foreign exchange and CFDs brokerages.

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The Bad – Market Volatility

Some will say that it is wrong to put market volatility in the ‘bad’ category in the case of looking at Brexit from a broker’s perspective. That said, as the industry has established in January 2015, too much of anything can be bad for business and in the case of Brexit this is most likely to be the case once more.

With the implied one month volatility of the British pound likely to hit an all time record in the coming 10 days, brokers have been preparing for the event and are heavily relying on a series of stop gap measures to limit their market risk and protect their clients. As we established during the Swiss National Bank crisis, this is equal to protecting the brokerage itself.

‘crowd wisdom’ could be right this time around

While a number of pundits are calling for one or another outcome for the British pound and stocks from the referendum, the likelihood that retail clients will suffer from the event is pretty good, which is not a positive for the industry in the long run.

A different aspect of the referendum is that the ‘crowd wisdom’ which is typically considered by market makers as a contrarian indicator can prove some of them wrong this time around. After all, British citizens are the crowd that is going to the ballot box to cast their vote on a very important issue, and they will be the masters of the outcome.

The Ugly – Panic

With so many unknowns on how is the referendum is likely to play out, the outcome could drive the markets to panic mode, which will result in one certain outcome – a lot of money will be lost by investors and traders.

“How is this affecting the industry?”, one might ask.

When markets panic, investors lose money and governments step in to ‘cure’ the markets

The answer is ‘more regulation’, the ailment of all the participants of the securities markets industry and one of the main causes of the great depression and the secular stagnation that followed. When markets panic, investors lose money and governments step in to ‘cure’ the markets and establish new regulatory norms.

The Best – Not Another SNB!

Deviating away from Segio Leone’s 1966 classic, we have to add another aspect of the outcome from the British Brexit referendum. The best thing about Brexit is that it is anticipated and all the companies in the industry have had time to prepare.

A Brexit event is not going to be another SNB crisis. There are no currency pegs, and the market is left to do what it does best – be the discounting mechanism that allows investors to prepare for a certain outcome.

The only thing we know for certain is that there will be a result from the event – something that was not present nor anticipated (in most cases) by the industry during the Swiss franc’s 30 per cent rally. With the market open during the votes tally, market participants will have bits and pieces of information to digest. The information flow on a constant basis that is affecting the risks across set classes will permit brokers to put in place various measures to address volatility.

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