On Thursday, January 15th, most U.S. traders awoke to find that the Swiss National Bank (SNB) had removed its exchange rate floor of 1.20 on the EURCHF. As a result, the Swiss Franc’s (CHF) value instantly shot up by as much as 39%, sending the EURCHF pair over a 1000 pips straight down.
By Friday, January 16th, Alpari UK had filed for insolvency, while New York-listed FXCM Inc, (one of the biggest platforms serving online and retail traders), said it may be in breach of some regulatory capital requirements after its clients suffered about $225 million in losses.
“We are actively discussing alternatives to return our capital to levels prior to today’s events and discussing the matter with regulators,” FXCM said in its brief statement Thursday. Citi analyst William Katz warned clients “the severity of the impact is likely to question the sustainability of the retail platform.”
At first the full impact of all of this was not completely understood but now, a few days later we are beginning to see the remains of several brokerages picked apart by vultures.
To illustrate what all this means, and why it could cost you, let me explain how some brokers work.
Many brokers simply pass on your trades to what is called a “liquidity provider” in order to eliminate all of their risk on the trade.
In case “liquidity provider” is a new term for you, here’s what MarketsWiki.com says:
“A liquidity provider connects many brokers and traders together, increasing the liquidity of the joint market. A higher liquidity is desirable for everyone, as it drives down the spread and thus the cost of trading. Liquidity providers are often large banks and other financial institutions. In forex trading, the world’s largest liquidity provider is the Deutsche Bank.”
Under normal market conditions and based on traditional thinking, these are the safer firms. However, these are the firms that seemed to have taken the biggest hit. Why?
That’s because normally, when you deposit your funds, they are transferred to an “omnibus account,” which is simply an account held with the liquidity provider your broker uses. This account is a pooled account of all client funds. It is segregated from company funds. So, as you make trades, these trades are passed to the liquidity provider, and any credits and debits are made from this omnibus account.
When a large gap like this occurs, all the accounts that were on the losing end of this move lose significantly more than what each individual has on deposit. So, the losses that exceed the amount they have eat into the funds from other people until the entire omnibus goes debit.
In many cases, this is significant and the net capitol the firm has on hand may not come close to covering the overall losses, and therefore, not only goes out of business, but in extreme cases is unable to pay back all the clients who still have money left. This is a rare occasion when the broker becomes the victim because technically, all the debt belongs to the trader.
Now, for firms that are taking risk on trades (i.e. they are not passing them on to liquidity providers), when a large loss like this occurs, the loss just goes to them, and they typically forgive the debt from the gap and all is good. The challenge is finding a firm that covers their own trades and is large enough to handle a situation like this that goes in the favor of the customer.
All that being said, who stands out in all of this?
If you’re in the U.S., Gain Capital looks good. They are showing stability and, in all likelihood, will own FXCM before this is all over. In a statement release January 16th, their CEO said:
“Our strong risk-management framework allowed us to generate a profit on one of the most turbulent days for the global currency markets in recent years. We remain focused on managing our risk, taking a conservative approach to managing our exposure to global currencies, while providing liquidity and high-quality execution to our global client base. Events such as the SNB announcement, although unexpected, can be mitigated in their impact using a comprehensive, consistent approach to risk management, a focus on maintaining robust, scalable trading technology and vigilantly focusing on our customers. We have positioned ourselves to effectively manage risk during both calm and tumultuous markets and our performance during this recent event shows that.”
Outside of the US, there is a firm that makes the market for their clients, and does it fairly and also is extremely well capitalized. In fact, they are backed by a multibillion dollar hedge funds.
The firm’s name is Institutional Liquidity (ILQ), and they are registered in Australia. so they are in a great regulatory jurisdiction and a very safe option relatively speaking. As their name implies, they typically only deal with Institution clients. Usually, you can’t go directly to them and get an account unless you are an institutional client.
However, Guardian FX currently has an arrangement that allows you to get an account with them averaging 1.5 pips spreads, and it comes with a 75% Margin bonus on up to $250,000.
So, if you’re outside the U.S., this is the place to be as they came through this with flying colors.
To open an account with ILQ you must have an institutional introduction. Clicking this link will allow you to open an account and receive the 75% margin bonus through Guardian Trust FX Click Here to register. Your account will be with ILQ, but Guardian will be the institutional party.