The Writing Was on the Wall: How the EUR/CHF Gap Hit Brokers with Massive Client Defaults
The huge risk I saw was to STP brokers, like AxiTrader. When I ran through a stress test of what
The following blog post is written by Quinn Perrott, Co-Founder and former General Manager of AxiTrader (now in retirement).
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When I was at AxiTrader back in 2013, I was intrigued by EUR/CHF carry trade (essentially being long EUR and short CHF to pocket the swap or interest rate differential) that was building with customers increasing their position daily.
The interesting thing about the EUR/CHF carry is that it relied on two unique factors: First, the perception the SNB would maintain the 120 peg. Second, it required extremely high exposure and leverage (usually 400:1) to reap relatively small swap profits. Clients negated or ignored the risk of the second factor because of their perception that the peg was ‘invincible’ (the first factor).
The huge risk I saw was to STP brokers, like AxiTrader. When I ran through a stress test of what would happen if the SNB gave up its peg (by stopping their policy of buying an unlimited amount of EUR at 120 CHF) I was shocked. What I foresaw in the case of the peg being removed was a drop from 120 to 110 with no liquidity in between, that would cause clients who should have been stopped (or margined out) out at say 119, actually being stopped at 100 and suffering 10 times the losses that they had adequate funds for. So an account with $5,000 equity would lose $50,000, creating a $45,000 debt to the broker, or negative equity as it’s often called in the industry.
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In this scenario, an STP broker would ‘lose’ $50,000 to the interbank market but only ‘gain’ $5,000 in client cash and a $45,000 debtor. Who said STP was the risk-free model? My response was to immediately assemble my team of compliance and risk management and our CEO.
What we decided was that even though the likelihood of the SNB changing policy in the near future was slight, it was a very real Black Swan and the risk/reward ratio wasn’t worth it. We decided we didn’t want these trades and had to get out of them in an ethical way that was fair and didn’t hurt the clients. We informed the clients that in 3 days’ time we would be reducing maximum leverage on the EUR/CHF pair from a maximum of 400:1 to 20:1 (if my memory serves me correctly). The clients took it well, closed their positions (generally at flat or a small profit) and probably moved to another broker.
Shortly afterwards, many of the astute brokers followed suit, including my wise friends at Pepperstone, who moved immediately after AxiTrader. Then yesterday the Swan came home to roost and many brokers who had still allowed high leverage EUR/CHF, though they offlayed the risk through STP, would be badly bruised (if not dead) today.
I can’t say I feel any pity for them, I only hope this doesn’t spur the regulators in to a knee jerk reaction or leave clients weary and scared to trade. Hopefully, it can weed out some of the less professional brokers and leave the industry stronger in a way Darwin would be proud of.
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very professional,
kudos to your guys.
Might stop the FCA lincencing anyone who can spell their name and pay the fees.
Same old story: too much leverage and Central Bank bs kills lots of people.
Takeaways:
1) Leverage over 50:1 should be banned.
2) Central bankers should all be jailed for 50 years for being fckwits
How about non-stp brokers? Can we assume most mm brokers are on the safe side in the event like this? Should client choose mm brokers instead?
Changing the leverage on one pair would not have helped given most damage was done in USD CHF.
Not just brokers, but traders as well.
Well, nobody is perfect.. The central bank takes money from the people and I embezzle my clients money.. That’s life!
What this article demonstrates is the importance of risk management and risk-level will differ from currency to currency. Leverage does not have to be decreased across the board, instead it can be better managed – Months ago banks asked for larger margins from brokers holding Swissy positions, it was imperative for the broker to pass this on to their clients. The ones that did were safe (to some extent) the ones that didn’t got hurt. A very inciteful article, thank you Quinn.
“120 to 110 with no liquidity in between, that would cause clients who should have been stopped (or margined out) out at say 119, actually being stopped at 100 and suffering 10 times the losses that they had adequate funds for. So an account with $5,000 equity would lose $50,000, creating a $45,000 debt to the broker, or negative equity as it’s often called in the industry.” This makes no sense to me. If somebody holds 5.000 in equity and can leverage 400:1, then his open EURCHF positions would be 400 x 5.000, which means 2.000.000. If, with a short… Read more »
hmmm. The peg is at 1.2000 CHF to make 1EUR. but yes, as the CHF appreciates in real time, the value goes to as much as .85 CHF to make 1 EUR. But to keep the example simple, let’s say that the cost per pip stays at 1.2CHF = 1EUR, OR the inverse 1CHF = 0.83EUR. The account balance should also be in EUR to keep the example simple. 4,000 pips @ $ 166 EUR a pip = $664,000 EUR loss [1:400 leverage and 5k eur balance, maxed out position can be 2,000,000, or 20.0 lots x 8.3 EUR per… Read more »
@ Jon – I think there is no grammatical error involved here. Lots of people call themselves risk manager, and talk about stress tests etc. However, the most simple things escape them. A 1:400 leverage is a road to hell for the broker, the moment markets spike out fast so that there is no liquidity to close the position in time. due to the leverage, a person’s equity is wiped out with a 0.25% move, and when we have 30%, then there is no ‘trader’ anymore, its just the broker. No way that these people did not know this in… Read more »