The CHF blood bath, explained

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.


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.


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.

DARWIN instead of PAMM? – the trader view

You already manage friends & family money via PAMM or MAMM schemes, and legitimately ask: DARWIN instead of PAMM?

Granted – if you’ve traded for long enough, listing a DARWIN is hardly inventing the “managing investor capital / healthy leverage” wheel.

Here’s our take: listing a DARWIN is fully compatible with managing capital elsewhere, because your listed DARWIN is…

Incremental & Anonymous

All we do is source additional capital for investable strategies. You keep whatever existing arrangements you choose to keep.

You’re not required to to disclose your identity to investors or use your commercial trading name (we will not know, unless you choose to disclose!). NB: as an FCA regulated manager, we take our obligation to identify customers very seriously, but this is a different matter altogether.

Needless to mention, if you’re managing capital for a higher success fee elsewhere, that´s fine by us!


Whether you hold regulatory license to manage investor capital, or not, DARWINs are legal, for legally and to a large extent economically (since we manage investor risk independently) it’s Darwinex that manages capital invested in your listed DARWIN.

We’re OK taking on that responsibility because our proprietary risk management framework protects investors from unexpected losses. Not to mention that investors value the additional safeguard, which results in your benefit.


Your DARWIN’s Investor Appeal is rigorous, independent and intuitive. Rating your experience, risk management, discipline, timing, performance and scalability, provides you with an unique opportunity to shine where lucky monkeys struggle.

Further, since high investor appeal predicts future risk adjusted return better than conventional risk/return measures, skilled traders enjoy more investor credibility, faster, than they could accrue individually, all at no effort or expense other than importing an existing track-record from a generally inferior broker.

Last, but not least, the DARWIN process aligns traders with investors for mutual long term success. By NOT rewarding traders for investor commissions, DARWINs overcome perverse incentives wherebyPAMM managers are conflicted into writing their own pay-check at investor expense (all it takes is rake in a bunch of trades and churn investors to “solve” a bad trading month).

High trader payout

Do you think that  15% DARWIN take home success fee is less than 30% on a PAMM account?

Think again. To earn your 30% PAMM success fee you:

  1. Earn 30% on spreads and commission schemes which are likely higher than our execution costs
  2. Carry your regulatory license (or at least, ought to)
  3. Ought to take customers through a suitability assessment (or risk legal action, if you fail to)
  4. Attract your investors – carrying little credibility, since you’re not credible if advertising your own talent
  5. Care for existing investors – who will tell them that managing a PAMM account does not amount to becoming their financial crystal ball?
  6. Run multiple versions of the same underlying strategy to cater to different investor risk appetites

Reflecting on the above, is 15% incremental NET, without sunk cost, really a bad addition to less 30% GROSS with sunk cost?

S0, to DARWIN or not to DARWIN?

That’s the thing: DARWIN is not a forced choice, but an additional option for anonymous, legal and credible revenue at 0 sunk cost, particularly since, unlike PAMMs, DARWINs don’t leak intellectual property to investors… but that’s a topic for another post!