The Writing Was on the Wall: How the EUR/CHF Gap Hit Brokers with Massive Client Defaults

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.

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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