Following IG Group stating that they were on the hook for up to £30 million in losses due to the volatility in the Swiss franc (CHF), industry questioned, “If IG lost that much, imagine how bad it was for FXCM?”. Answering that question, the broker has released a statement that client negative balances due to the move in the CHF reached $225 million.
The figure was well above the $100 million estimates floating around the market. As such, the losses from clients may also include exposure from their recently launched Prime of Prime Broker solution, in which many smaller hedge funds are known to have operated ‘run away’ algorithms which wiped them out on the move.
According to FXCM, the negative balances which in the terms and conditions with retail clients they don’t try and collect, has resulted in negative debit balances, stating, “The company may be in breach of some regulatory capital requirements.” The company added, “We are actively discussing alternatives to return our capital to levels prior to today’s events and discussing the matter with our regulators.”
As a straight-through processing broker, with customers being predominately short the CHF, FXCM held a corresponding position with their bank counterparties. At the time of the fall in the EUR/CHF and USD/CHF, clients with long positions experienced massive losses, with stop out prices reported over 10% lower to around 1.0400 for the EUR/CHF.
For anyone whose positons were above 8X their balance, it resulted in a complete loss for their account. Many customers with larger leverage saw their accounts going negative.
For FXCM and other STP brokers or those like IG with large hedged franc positions, the negative balances make it nearly impossible to mitigate their own losses suffered on their CHF short positions with their bank counterparties. Brokers are also suffering as banks have alerted customers that pricing of some executed trades may be incorrect.
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Two specific firms which have been cited as providing poor execution by brokers are Barclays and UBS. As a result, when final reconciliation of hedged client fills is calculated, trades that were profitable may result in losses.
In terms of the $225 million quoted by FXCM, the amount reveals one of the dangers of being a broker; credit risk from clients losing more than their balances. This problem has been reported to have caused several prime brokers to suffer losses in 2014 due to ‘run away’ algos triggering losses.
Typically, retail brokers don’t require account holders to cover debt related to negative balances and rely on their risk management software to close client positions before they go negative.
In this extreme case, although FXCM is on the hook for $225 million to their liquidity partners, collecting the funds from clients will be difficult. What is not yet known is what percentage of the $225 million figure is from institutional clients who may have the resources to pay their debt from other accounts they hold with other counterparties.
FXCM Inc (NYSE:FXCM) lost 33.5% in trading yesterday, before issuing a statement about its losses from the Swiss franc bomb thrown on the currency markets amounting to $225 million late evening.
The real impact of the $225 million number will be felt in trading today, as the stock market digests the officially announced figure and the implications for the firm stemming from the prospects of a capital requirements breach.
In what was undoubtedly the most difficult of times for the foreign exchange market participants since the breakup of the European Monetary System in 1992, the foreign exchange markets Black Thursday is likely to have caused major financial and reputational damage across the industry.