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The CHF blood bath, explained

17 January 2015

48 hours into the CHF debacle, it’s always healthy to carry out some post-mortem analysis to learn the lessons of why it happened, and what we could have been done to weather it better.

Since we’ve done it, why not share it?

The macro-story: Black-Wednesday, redux

What happened is crystal-clear with the benefit of hindsight (as it always is).

The CHF is a currency safe-haven, albeit a rather illiquid one, since it’s only backed by a tiny and financially hypertrophic economy. Ever since the EUR crisis, everyone and their mother placed some of their safety net in CHF – so much so that the Swiss National Bank was forced to ¨intervene¨ to keep the level at 1.20 to the EUR.

The intervention mechanism was: whoever bought CHF close to 1.20 sold to one counterparty, and one counterparty alone – the SNB. In broker parlance, the SNB became the daddy of all market makers by being the only player in the market with “unlimited” access to CHF close to the 1.20 EUR/CHF cliff. This filled the balance sheet of the SNB with foreign currency reserves… above all with a boatload of EUR, for EUR area is the Swiss’ primary commercial partner and the home currency of nervous europeans who by now trust neither their “unbreakable” currency, nor their tax-agency (the latter being food for another post).

With the EUR crisis on its way back (it has never really left…), the EUR has gone on free-fall, and EUR reserves were drilling the daddy of all P&L hits in the SNB balance sheet. That was before Herr Jordan got Mario’s phone call kindly announcing QE. Herr Jordan’s press conference is (financial) history being written as we speak.

Black Wednesday on September 16th, 1992, George Soros hit the headlines. Actually, he didn’t until after the dust had settled.

On the January 15th Donnerstagsdebakel (made this up, but it’s fitting for Thursday is the day of Thor and Thunder, depending on the language you choose), someone else hit the Jackpot.

We don’t know the name of the winner yet: journalists are still chasing around for a name and a photo to head their scoop… but if you want an outline of his likely background, read on.

The (retail) micro-story: Dancing on a cliff

We (traders, brokers, broker-dealers, and dealers) went about our business, nonplussed.

Traders saw juicy price-action dynamics at that level, and brokers readily offered (leveraged!) trading access to the CHF. Again with hindsight, everyone was dancing on a cliff… not wondering too much what would happen if (actually, when) Hoover Dam fell.

Dancing-on-Glacier-Point-03

So far, all pretty standard, really.

The interesting (and sad) bit, and the one that has received the least early attention is that the Fall affected brokers (A-Book) and dealers (B-Book) in tragically different ways – just as you’d expect it, for brokers trade with customers and dealers trade against them.

This effect IS news, because what went belly up on Thursday is the capillary over-the-counter (OTC) system of broker-dealers that makes currencies flow world-wide.

a-book, aka involuntary (unprepared!) contingent market makers

The moment the previous market maker (the SNB) went on strike, Hover Dam fell and sent the EUR on free-fall against the CHF – which called the next market makers to action: customers short the CHF and their collateral posted with their agency-only brokers and Prime Brokers (we’re pure A-Book).

Once that was exhausted (the higher the leverage offered, the quicker), brokers’s and Prime Brokers’ stop-losses triggered, but there was no market, so the margin we had posted with our Prime Brokers was the market. We, a-book brokers became involuntary (and ill equipped) market makers of last resort, not against our retail customers, but our wholesale counterparties.

Technically we ran no risk since actually it was our customers shorting the CHF who got smacked. In practice, FXCM (and others!) now know better: you can’t hire an army of lawyers to track thousands of micro-debts because each debt is smaller than 30 min of lawyer fees.

So there you go.

If you’re looking for victims, you’ll find more than your fair share in the lines of pure agency Brokers and Prime-Brokers who catalysed spot foreign exchange flows between macro (Tier 1 Banks and Central Banks)market makers and micro (Hedge-Funds, retail traders, Tier 2 institutions) price takers.

b-book, unregulated retail bucket shops

The retail spot forex trading arena contains close to 1000 unregulated, undercapitalised, over-levered retail dealers (= bucket shops) who make markets against FX punters.

(How or why they are allowed to invest massive amounts into advertising to earn business in regulated markets escapes our understanding, but that’s for another blog post.)

More to the point, how did they fare? Just fine, thank you.

They kept the deposits of those short the CHF, as they always do – and they didn’t have any losses with wholesale counterparties to match (all they do is trade against customers, remember?).

So how about the winners? You can bet that many of those outfits will keep the P&L of winning customers (there was no market, re-quotes, blah-blah), as they always do. That’s when operating an unregulated casino comes in particularly handy.

So there you go.

If you’re looking for more victims, go find would have been genius… who discovered a tad too late that trading with an unregulated bucket shop is a variation on the age old “heads I win, tails, you lose” coin toss.

They could have been George Soros, but learnt the concept of counterparty risk instead.

Darwinex

We came out of this just fine, mainly because we did most things right, and partially because we were lucky.

What we did right was to anticipate the on-exchange move. We have been clearing all our flow with LMAX (a MiFID regulated MTF), partially because we think that there’s too much information asymmetry in OTC forex, partially because Exchanges facilitate clearing and settlement (go ask Saxo customers being re-quoted on their CHF trades), and generally because we think that on Exchange is the proper way of doing things.

We had minimal CHF exposure, both in absolute terms and in relative terms both to the bulk of our business and our capital base. We weren’t watching much (there was no need), took a tiny hit. 3-quarters design, 1 quarter luck, bottom line is we came out just fine, and a lot of our users are now migrating incremental funds to us, which is a great honor.

All in, this was the cheapest life-saving lesson we will ever learn. And you bet we’ve learnt it.

The road from here

It was probably going to happen, and the regulators were probably looking for a justification… and now they’ve got it.

The Spot currency exchange market is the biggest OTC market in the world. Because it’s also the oldest, it stayed OTC way after technology and common sense recommended the move on exchange. What held that back was the mess of having to put in place an alternative to the network of broker-dealers that kept currencies flowing, unknown to the general public and most of even informed people in finance . It was clunky alright, but it worked.

If anything blew last Thursday, it was the very internal pipes that kept the OTC foreign exchange market flowing. Tens of legitimate financial outfits will spend some time working out just how much they lost… others are simply gone. With the pipes gone, the regulatory ought to do do has become an urgency must do

If you have an opportunity to invest into a Multi-Lateral Trading facility that clears foreign currency, you can bet they’re going to be faceless big time winners of this, alongside the next George Soros. We, for one, have been trading with one because this bit we did see coming.

Last News
MiFID 2

Gearing up for MiFID 2: our preparations and plea to ESMA

19 September 2017

MifiD 2 – a pan-european piece of financial legislation applies from January 3rd, 2018. 10 years in the making, MifiD 2 builds on its predecessor, “to improve the functioning of financial markets, making them more efficient, resilient and transparent.” Whilst the overall scope of MiFID 2 is way beyond our scope … MiFID 2 & Retail Brokerage […]

MifiD 2 – a pan-european piece of financial legislation applies from January 3rd, 2018.

10 years in the making, MifiD 2 builds on its predecessor, “to improve the functioning of financial markets, making them more efficient, resilient and transparent.”

Whilst the overall scope of MiFID 2 is way beyond our scope …

MiFID 2 & Retail Brokerage

But does it affect the retail brokerage industry?

Quite a lot. ESMA, the Pan-european regulator behind MiFID2, has its eyes set on CFDs – intervening using rare legislative prerogatives reserved for “high priority” situations.

Why is that? Because retail trading has grown a lot (the trader movement is strong!). Unfortunately, it’s done so with teething problems that need fixing, pronto. In its statement, ESMA announces regime changes combining (and hopefully harmonising) the various measures introduced by national regulators, including:

  1. Leverage limits,
  2. Guaranteed limits on client losses, and / or
  3. Restrictions on the marketing and distribution of these products.

National strategies so far – our take

If we were in ESMA’s shoes, we’d make retail OTC trading “efficient, resilient and transparent” by forcing CFDs on Exchange, because this would tame the conflict of interest between retail traders and market makers. Without conflict, who would want retail traders blowing up? What would be the point of leverage limits, guaranteed stop-losses or marketing restrictions? (Could this be why IG are working on their own MTF?).

If you want more insight on why, in our view, on Exchange is the only way:

The CFD dragon needs to be slain! – Darwinex

Alas, national regulators haven’t suggested on Exchange for now… so we hope whatever ESMA comes up with overcomes the limitations of:

  1. FCA: Leverage limits (NB the FCA has since delayed policy to follow ESMA)
  2. BaFin: Guaranteed limits on client losses as introduced in Germany…

MiFID 2 – the Darwinex way

In any case, we’re luckily not in ESMA’s shoes (not an easy job!). We’re in our own – and there’s plenty we can – and will – do in the meantime.

Since launching Darwinex broker 3 years ago, we’ve NEVER traded against customers (and NEVER will). Instead, we invest in them. Slowly but surely… the likes of NTI prove that listing independent traders creates an asset, and that investor leverage is the sustainable business model.

And yet, on Exchange or off Exchange, more and more people actively invest their savings. Which unfortunately also means too many gamble away more than they can afford. The problem is: too many quit before learning how to do it. Because that’s bad (for them and for us), we’re re-vamping on-boarding procedures for even more alignment and transparency.

Without disclosing methodology & parameters (this could incentivise people to “game” the system against their own best interest), available leverage for users will depend on:

  1. Proven or proveable experience/training when trading with leverage
  2. Solvency – because no-one should risk capital they can’t afford to lose

MiFID 2 – what it means in practice

NB: all users will be allowed to purchase DARWINs – within their stated risk appetite. This is because DARWINs are comparatively low leverage (rarely more than 5:1)

We will segment the Trading user base using both pieces of information, and transition from:

  1. Inappropriate -> the aspiring traders’ gaps in either or both criteria are too large. We won’t accept his trades until he’s ready (watch out for more news in the educational space)
  2. On transit -> it’s appropriate for the user to trade, but we will restrict the leverage he can deploy
  3. Unlocked -> user has acquired enough experience. We will offer him/her all the leverage available to customers at any given time

We will disclose our internal categorisation to customers so they know where they are in their evolution from “novice” to “maximum” leverage.

In addition to the above segmentation, we will apply two further controls:

  1. For investors: from day 1, the risk management engine tracks Equity at Risk (EaR) for every investor portfolio. Investors can’t buy more exposure than their maximum risk threshold at any point in time – investors can only sell once they reach the maximum threshold
  2. For all customers: we will track customers’ overall P&L (for trading and investing), informing them about it. We will also warn when the threshold is exceeded. And we may withdraw permission to trade if we feel it’s inappropriate for him/her to continue trading

Last, but not least, the restrictions apply to new customers only.

German General Election (24 September 2017)

Please note that German General Election is coming up this Sunday (24 September 2017). Exit polls are due to come out shortly after polling stations close at 17:00 (UK time) and preliminary results may be announced before Sunday market open 22:00 (UK time), which may result in market gapping in EUR related products. Please make […]

Please note that German General Election is coming up this Sunday (24 September 2017). Exit polls are due to come out shortly after polling stations close at 17:00 (UK time) and preliminary results may be announced before Sunday market open 22:00 (UK time), which may result in market gapping in EUR related products.

Please make sure you are comfortable with the open position exposure on your Darwinex account and that you have sufficient margin cover going into the weekend prior to market close at 22:00 (UK time) on Friday (22 September 2017).

As always, at info@darwinex.com we’ll be glad to assist you!

And the DarwinIA winners are…

1 September 2017

The August edition of our DarwinIA trading challenge came to its end. Below you can find the 48 winners of our € 4,000,000 notional allocation for a 6 month period. Place DARWIN August’s notional allocation 1st $CJN € 300,000.00 2nd $UYZ € 250,000.00 3rd $DLF € 210,000.00 4th $XGU € 170,000.00 5th $VQB € 150,000.00 6th […]

The August edition of our DarwinIA trading challenge came to its end. Below you can find the 48 winners of our € 4,000,000 notional allocation for a 6 month period.

Place DARWIN August’s notional allocation
1st $CJN € 300,000.00
2nd $UYZ € 250,000.00
3rd $DLF € 210,000.00
4th $XGU € 170,000.00
5th $VQB € 150,000.00
6th $JJP € 140,000.00
7th $XEC € 130,000.00
8th $LZL € 120,000.00
9th $OOC € 110,000.00
10th $LDR € 110,000.00
11th $LDZ € 110,000.00
12th $LVS € 100,000.00
13th $FTT € 100,000.00
14th $ERQ € 100,000.00
15th $PGH € 90,000.00
16th $QJW € 90,000.00
17th $DDY € 90,000.00
18th $HIB € 80,000.00
19th $KYQ € 80,000.00
20th $TTK € 80,000.00
21st $VTJ € 70,000.00
22nd $WPQ € 70,000.00
23rd $KAR € 70,000.00
24th $TOP € 70,000.00
25th $ELD € 60,000.00
26th $UEI € 60,000.00
27th $HFS € 60,000.00
28th $PFI € 60,000.00
29th $VFL € 60,000.00
30th $JCW € 60,000.00
31st $QTB € 50,000.00
32nd $HKM € 50,000.00
33rd $GPZ € 50,000.00
34th $PEW € 50,000.00
35th $XBX € 50,000.00
36th $YHN € 50,000.00
37th $BAN € 50,000.00
38th $LYX € 40,000.00
39th $JGC € 40,000.00
40th $AGD € 40,000.00
41st $SLR € 40,000.00
42nd $FGC € 40,000.00
43rd $RAO € 40,000.00
44th $THA € 40,000.00
45th $WZG € 30,000.00
46th $TKT € 30,000.00
47th $XMZ € 30,000.00
48th $RQH € 30,000.00

Updating our MT4 server

31 August 2017

Please note that we are updating our MT4 live server to Build 1090. Demo Server will be updated on 9 September 2017 and our Live Server will be updated on 24 September 2017. Should you experience any connectivity issue after the update, please click here to download the latest version of our MT4 terminal. Also, we […]

Please note that we are updating our MT4 live server to Build 1090. Demo Server will be updated on 9 September 2017 and our Live Server will be updated on 24 September 2017.

Should you experience any connectivity issue after the update, please click here to download the latest version of our MT4 terminal.

Also, we have been notified by MetaQuotes Software Corp. that as of 1 October 2017 (Sunday), support for MetaTrader 4 client terminal versions below 1065 will be discontinued, so please make sure you update your MT4 Terminal to the latest version before then.

Support for Windows XP, Windows 2003 and Windows Vista will be discontinued for the MetaTrader 4 platform on 1 October 2017, too. As potential hardware capabilities can no longer be recognised, these operating systems are considered to be outdated.

MetaQuotes has stated that Windows 7 is the minimum required operating system version for running MetaTrader 4. However, using the 64-bit versions of Windows 10 is strongly recommended.

Older versions of MetaTrader 4 will continue to work on Windows XP, Windows 2003 and Windows Vista. After 1 October 2017 (Sunday), updates will no longer be received and installers will not run on these operating systems. Without having your MetaTrader 4 up to date, you may not be able to execute trades or have guaranteed stability.

As always, feel free to contact info@darwinex.com if you have any questions or need a solution for this change!

Darwinex Amended Trading Hours due to U.S. Labour Day

Please note the amended Darwinex trading hours for the upcoming U.S. Labour Day on 4 September 2017 (all times are in UK time). Important: commodities will close 5 mins ahead of market close to avoid liquidity shortages.  Instrument Trading Hours  FX 22:05 Sun – 22:00 Mon   DARWINS 22:05 Sun – 22:00 Mon  COMMODITIES   Gold* […]

Please note the amended Darwinex trading hours for the upcoming U.S. Labour Day on 4 September 2017 (all times are in UK time).

Important: commodities will close 5 mins ahead of market close to avoid liquidity shortages.

 Instrument Trading Hours
 FX 22:05 Sun – 22:00 Mon
  DARWINS 22:05 Sun – 22:00 Mon
 COMMODITIES  
Gold* 23:00 Sun – 17:55 Mon
Silver* 23:00 Sun – 17:55 Mon
Platinum* 23:00 Sun – 17:55 Mon
Palladium* 23:00 Sun – 17:55 Mon
US Crude* 23:00 Sun – 17:40 Mon
Natural Gas* 23:00 Sun – 17:40 Mon
 INDICES  
Australia 200 23:00 Sun – 22:00 Mon
 Europe 50 23:00 Sun – 22:00 Mon
France 40 23:00 Sun – 22:00 Mon
Germany 30 07:00 – 21:00
Spain 35 08:00 – 19:00
Japan 225* 23:00 Sun – 18:00 Mon 
 UK 100 23:00 Sun – 22:00 Mon
 US SPX 500* 23:00 Sun – 18:00 Mon
 US Tech 100* 23:00 Sun – 18:00 Mon
Wall Street 30* 23:00 Sun – 18:00 Mon
*Amended Darwinex trading hours.

As always, at info@darwinex.com we’ll be happy to assist you!

Introducing conditional orders

23 August 2017

Regular DARWIN investors know best – DARWINs can be leveraged for active management in addition to passive investing. Having said that, one thing many have rightfully requested were conditional orders. How about: Stop my loss if a DARWIN now quoting for 137 drops to 122?, or Take my profit once my DARWIN currently listing at […]

Regular DARWIN investors know best – DARWINs can be leveraged for active management in addition to passive investing.

Having said that, one thing many have rightfully requested were conditional orders.

How about:

  1. Stop my loss if a DARWIN now quoting for 137 drops to 122?, or
  2. Take my profit once my DARWIN currently listing at 225 touches 240?
  3. Setting a Buy Limit order to buy a DARWIN when its quote goes below X?

Introducing Conditional Orders

Yes – conditional orders are already available in demo mode!

Try your demo portfolio now!

They’re here in that they’re already available in demo mode in the production environment. And that’s why they’re almost here. Since this is a reasonably complex functionality, we thought it best to launch conditional orders in demo mode and defer deployment in the live funds platform until we’ve gathered your feedback. On that note:

  1. We’ve scheduled an explanatory webinar for the 29 August 2017. You can register for our webinar here.
  2. We’ve drafted a detailed guide on how to use the functionality.
  3. We will be grateful for your feedback in:
    1. Identifying bugs
    2. Improving the FAQ documentation
    3. Improving the implementation

Note that conditional orders won’t be available in the mobile app. We’ll wait to roadtest the desktop application in demo mode until we’re all comfortable that things are working as expected.

As ever, info@darwinex.com will be delighted to take your feedback or clarify any questions as they no doubt will arise.

Trade safe everyone!