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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

Australia Public Holiday on 10th June 2019

5 June 2019

Please note the amended Darwinex trading hours for the upcoming Bank Holiday in Australia on 10th June 2019 (all times are in UK time).

Please note the amended Darwinex trading hours for the upcoming bank holiday in Australia on 10th June 2019. All times are in UK (BST) time.

Indices  Monday 10th June 2019
AUS200 08:10 – 22:00

 

The rest of the assets will trade according to their usual trading time.

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

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Upcoming holiday in New Zealand resulting in the possibility of wider spreads and thinner liquidity

30 May 2019

Please be aware that there is a bank holiday in New Zealand on Monday June 3rd. Therefore, during this time, spreads may be wider and liquidity may be thinner for all NZD-related assets. For any questions, we’re one email away, at info@darwinex.com.

Please be aware that there is a bank holiday in New Zealand on Monday June 3rd.

Therefore, during this time, spreads may be wider and liquidity may be thinner for all NZD-related assets.

For any questions, we’re one email away, at info@darwinex.com.

US Memorial Day & UK Spring Bank Holiday on 27th May 2019

14 May 2019

Please note the amended Darwinex trading hours for the upcoming US Memorial Day & UK Spring Bank Holiday on Monday 27th May 2019. All times are in UK (BST) time. Important: if you open / close an investment in a DARWIN that has an open trade in an asset with the market closed (see amended trading […]

Please note the amended Darwinex trading hours for the upcoming US Memorial Day & UK Spring Bank Holiday on Monday 27th May 2019. All times are in UK (BST) time.

Important: if you open / close an investment in a DARWIN that has an open trade in an asset with the market closed (see amended trading hours in red below), the transaction will not be carried out immediately. The operation will show up in your investor portfolio once it has been executed by our system when the index/commodity resumes trading on Monday night.

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

Commodities   Monday 27th May 2019
Gold 23:01 Sun – 18:00 Mon
Silver 23:00 Sun – 18:00 Mon
Platinum 23:00 Sun – 18:00 Mon
Palladium 23:00 Sun – 18:00 Mon
US Crude 23:00 Sun – 17:45 Mon
US Natural Gas 23:00 Sun – 17:45 Mon
Indices
UK100 CLOSED
J225 23:00 Sun – 18:15 Mon
SPX500 23:00 Sun – 18:15 Mon
NDX 23:00 Sun – 18:15 Mon
WS30 23:00 Sun – 18:15 Mon
US Stocks
All US stocks CLOSED

The rest of the assets will trade according to their usual trading time.

UK100 closed on 6th May 2019

29 April 2019

Please note that on Monday 6th May 2019, the UK100 index CFD will be closed due to bank holiday in the United Kingdom.

Please note that on Monday 6th May 2019, the UK100 index CFD will be closed due to bank holiday in the United Kingdom.

The rest of the assets will trade according to their usual trading time.

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

Amended trading hours and changes to EUR swaps: 1st May 2019

24 April 2019

Please note that amended Darwinex trading hours will apply on Wednesday 1st May 2019. There will also be changes to the way EUR swaps get charged / credited during next week due to the bank holiday on May 1st. Indices Wednesday 1st May 2019 STOXX50E CLOSED FCHI40 CLOSED GDAXI CLOSED SPA35 CLOSED   The rest of […]

Please note that amended Darwinex trading hours will apply on Wednesday 1st May 2019. There will also be changes to the way EUR swaps get charged / credited during next week due to the bank holiday on May 1st.

Indices Wednesday 1st May 2019
STOXX50E CLOSED
FCHI40 CLOSED
GDAXI CLOSED
SPA35 CLOSED

 

The rest of the assets will trade according to their usual trading time.

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

Amended trading hours on ANZAC Day on 25th April 2019

22 April 2019

Please note that on Thursday 25th April 2019, the Australia 200 index CFD will open at 8:10 and close at 22:00 BST. The rest of the assets will trade according to their usual trading time.

Please note that on Thursday 25th April 2019, the Australia 200 index CFD will open at 8:10 and close at 22:00 BST.

The rest of the assets will trade according to their usual trading time.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71 % of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.