From Floating Spreads to Floating Margin, Brexit Awaits

This article was written by Ron Finberg, BD at Cappitech.

Volatility

Volatility during news announcements has been an ongoing factor that forex brokers have had to handle. It wasn't too long ago that this issue was primarily solved with fixed spread brokers evolving to variable spreads to reduce trade rejections of their clients entering orders at prices that were out of the market.

With technology advancements reducing latency, much of the out of the market price spikes that were common five years ago are now a thing of the past. But now a new news related trend has emerged: margin changes.

A result of forex industry-wide losses to clients and brokers alike from the January 2015 Swiss franc volatility, firms have been invoking temporary increases in margin requirements to handle upcoming volatile news periods.

Following the Swiss franc episode, the first cases of widespread margin increases took place ahead of Grexit related voting which were expected to cause the euro to spike.

Brexit

Presently, the latest news flavor of the day is Brexit voting. As a referendum is to take place on Thursday June 23rd to vote whether to remain in the EU or not, concern among traders is that the results may trigger abnormal bouts of volatility in FTSE and GBP trading. Reacting on this sentiment, a slew of brokers have announced to customers that margin requirements are being raised ahead of the voting. Examples are OANDA, Saxo Bank, FXCM and IG.

Ultimately, as trading markets have been adjusting prices to reflect the likelihood of Brexit voting, the margin changes will probably turn out to be unnecessary, In addition, ahead of the uncertainty, many traders have been reducing their exposure to UK related trades which decreases the chances of a 'Black Swan Black Swan A Black Swan event is most commonly associated with an unforeseen calamity or event. In its most basic form, this event results in disastrous consequences for multiple parties, markets, or individuals and are characterized as extraordinarily rare in frequency, yet are seemingly predictable in retrospect. In the foreign exchange space, the most noteworthy of these events in recent memory was the Swiss National Bank (SNB) crisis which roiled currency markets back on January 15, 2015.During this in A Black Swan event is most commonly associated with an unforeseen calamity or event. In its most basic form, this event results in disastrous consequences for multiple parties, markets, or individuals and are characterized as extraordinarily rare in frequency, yet are seemingly predictable in retrospect. In the foreign exchange space, the most noteworthy of these events in recent memory was the Swiss National Bank (SNB) crisis which roiled currency markets back on January 15, 2015.During this in Read this Term' type of Swiss franc event where positions have to be dumped quickly and create industry wide systematic risk. Also, due to voting taking place on a Thursday, forex markets will be open before, during and right after results are posted which reduces the chances of a major spike that is more common from a weekend vote.

As a reference case, despite worries ahead of Grexit voting and increased volatility that did take place on a few occasions of weekend voting, brokers were minimally affected by the moves. This was partially the result of various outcomes being priced into the market as well as a decrease in speculative trades. This compares to the Swiss franc crisis in which traders and brokers were caught off guard about the potential risks of Liquidity Liquidity The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent Read this Term evaporating.

Institutional trends

Despite what will ultimately be an event that the forex industry can handle, margin changes as a corporate action are likely to continue. This trend is already playing out in the institutional sector where upcoming regulatory changes such as MiFID II and BASEL III are raising reporting costs and increasing capital requirements for various asset types. The result is a greater emphasis on opportunity costs of capital and financial firms have been cutting exposure to capital intensive, but low margin businesses. Collateral management systems have also become, in higher doses, demanded on the buyside as a solution to best apportion capital spread between margin requirements of counterparties.

As financial firms become more dynamic in their apportion of capital, the likelihood is raised that they become more proactive in reducing collateral exposure during events of expected increased volatility. Prime examples are news events during which margin changes may become much more common and in a way similar to dynamic pricing of spreads around major economic indicator releases.

Retail forex

For the retail forex industry, changes in the institutional sector will trickle down to affect them as well. As such, if a broker's liquidity provider become more proactive with margin increases, it will force them to act accordingly. In the current Brexit environment this is taking place with smaller brokers using white label solutions having announced margin changes that are being dictated by their liquidity partners.

Overall, while an increase of temporary margin changes can be viewed as disruptive to retail traders, it is slated to be the offshoot of a larger trend in the trading market to reduce broker and customer risks.