It’s very easy to see the impact the recent decision of Switzerland’s SNB to remove the Swiss Franc (CHF) peg to the euro on retail forex outfits. These retail forex platforms, yes, the ones you see advertised on Google Adwords ads all over, have been smacked hard-to say the least. As anyone who trades forex knows, leverage is the name of the game. That’s the main reason why forex is even attractive to retail customers. Playing forex based on actual fully-covered positions require a lot of capital up front-capital which most retail customers don’t have. This is why most, if not all, forex consumer plays are leveraged through margin accounts. And what happens when too many customers end up on the losing side of a bet? That’s right-the platform steps in and covers the loss. This is precisely what happened recently through many platforms when the CHF appreciated against the euro to the tune of somewhere in the neighborhood of 40%. Forex outfits like FXCM, the largest retail player in the consumer forex space, had to get an emergency $300 million infusion just to stay afloat.
As nasty as this shock was, what impact would the CHF debacle have on broader finance markets?
Fund losses and capital diversion
Some funds took a hit from the CHF surge and either closed down or funds were diverted from their parent units to cover losses. Even Goldman Sachs wasn’t spared from the meltdown although Goldman’s losses were relatively small compared to other forex players. While capital would be diverted to cover losses and some funds had to close, the CHF debacle seems to be a relatively minor shock in the big scheme of things. Assuming no big revelations are made this quarter or next, it shouldn’t have an outsized impact on the broader market.
How did the crash happen?
A lot of forex players were hoping the ECB’s announcement that it would engage in quantitative easing would produce a crash in the CHF. Well, the SNB didn’t want to buy watered down euros and unexpectedly unpegged the CHF. Considering that there are other ‘safe haven’ currency plays and only a small minority bet big against the CHF, don’t expect the unpegging to cause more pain down the road. Of course, all bets are off if news breaks out of a big investment housing a heavy cross leverage arrangement ‘insured’ by a potential windfall from a bet against the CHF.