It’s been almost a year since the Swiss National Bank surprised currency markets with its decision to abandon the 1.20 EUR/CHF floor. After three years of stubborn insistence that the central bank’s policy is sustainable, the academics in charge of the Swiss monetary policy body conceded defeat and let the Swiss franc free float.
As a result, billions were wiped out from the market and stunningly, a number of foreign exchange brokers were hit by the black swan with the losses of their clients becoming their own. A year after the event, the Managing Director of ADS Securities London, James Watson, has highlighted the number of changes that transpired in the industry since.
“The SNB move was not an isolated event, it reflected the divergence in Central Bank policies which had started in 2014. Central Banks were increasingly adopting single market strategies and using all the tools at their disposal to try and ensure their own national economic recovery,” he explained.
Looking at 2016, we have to add that the divergent central bank policies are still ongoing, with a number of currency pegs threatened. From oil producing nations to export dependent economies in the far east, today, a number of currency pegs and managed floats are in danger.
Long Term Industry Impact Analysis from ADS
It is worth focusing on the outcome for the industry, that has affected a number of companies and has put into question a number of business models: from prime brokers to retail outfits, the revenue models and the pricing structure
Mr Watson elaborated: “The immediate outcome was that a number of good FX brokerages, trading desks and investors sustained large losses. Some were not able to recover from these losses. We had anticipated the risk associated with the EURCHF ceiling and in November 2014 changed our margins which helped protect us, but the longer-term effects are still being felt, and have changed the industry for all participants.”
The Three Major Industry Challenges
The take by Mr Watson is that the industry has faced a number of major challenges: the first point that he makes is that market participants from prime brokers to retail brokers are far more risk averse.
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“Most of the large brokerages have made significant investments in real time risk visibility systems, so that if there is another SNB type incident they can react. Brokerages who do not have these systems can provide a service, but they will be passing on large levels of risk to clients.”
With the reduction of the number of prime brokers on the market, the next challenge that ADS Securities highlights is related to the cost of credit.
“The number of FX Prime Brokers has been reduced, limiting the availability of trading lines, which has resulted in an increase in the cost of credit. This has created a move to Prime-of-Prime solutions, with well-capitalized brokerages now playing an increasing role in providing liquidity to the market,” Mr Watson explains.
Taking a look at the liquidity situation on the market, ADS Securities highlighted the rising costs to access liquidity.
“Liquidity has become far more finite and the cost of liquidity has increased. The industry is therefore looking at how it is structured and how the value chain is calculated so that Liquidity Providers (LPs) can continue to support a range of trades,” Mr Watson highlighted.
Outlook for the Years Ahead and Conclusions
ADS Securities correctly highlights the three most important points that long term traders are looking for in a broker: sufficient capital, solid regulation and proprietary technology are all important. However in his latest set of comments Mr Watson also underlines that some inevitable changes are coming to the market.
“The prices and spreads traders saw twelve months ago are long gone. If brokers offer ultra-low prices traders, and regulators, know that they are passing on extremely high levels of risk, which will probably be unsustainable,” he concluded.