On January 15the Swiss National Bank shocked the world with its announcement to remove the cap it had to prevent the Swiss franc from rising too high against the euro.
Note that since September 6, 2011 the Swiss National Bank had adopted the ceiling of franc against euro at the level of 1.20. The main defender of the Swiss currency Philipp Hildebrand (at that time the head of the Swiss National Bank) promised by all means to prevent the euro to cost less than 1.20 francs.
What has happened?
The Swiss National Bank has announced that the cap (1.20) of EUR / CHF currency pair is no longer justified and cut the interest rate from -0.25% to -0.75%, after which the most unexpected happened: within half an hour franc increased by dozens of percent against major currencies. Although the cancelation of the cap had been talked about for a long time, the majority of financial institutions and companies were not prepared for such an event and suffered serious losses. EUR / CHF currency pair decreased from 1.2 to 0.86 and then reached about 1.00 within half an hour. Other currency pairs with Swiss franc behaved similarly. Because of provision of high leverage this development hurt Forex brokers hard, even resulting in the bankruptcy of some of them.
Why the leading Forex brokers failed to protect their risks?
All the suffered brokers have one explanation – not enough liquidity on the market with strong volatility. Brokers with limited (intermediary) license (which is indicated in their customer agreement indicating the broker responsible for the transactions), are not under our consideration.
Let us explain the situation. At any time customers have long and short positions opened at different times and with different volumes – this forms the summed position of clients. When the price moves the summed position changes, Limit and Stop orders of clients can be performed, as well as the positions can be closed automatically due to the lack of funds. Brokers are oriented by the prices they receive from the interbank, i.e. from ECN systems, where the participants are banks and other large financial institutions.
Regardless how a broker arranges transferring of clients’ orders to the interbank, whether the orders are transferred seperately or summed, according to what business model the broker operates, only brokers carry the responsibility for clients’ trading activities.
Let us consider the shocking event on the example of the EUR / CHF currency pair. The situation with clients with short positions before the collapse of the rate is more or less clear. They either have profits by the current rate or have taken profit on their limit orders. The clients with long positions either have losses by the current rate or have suffered losses by their stop orders.
You may now ask: “Then what’s the problem?” It’s very simple. Clients trading with leverage less than 1: 3 did not cause any problems to brokers. The situation is different with the customers trading with high leverage – the funds on their accounts will cover only a small part of the losses and much more they will be obliged to pay.
On January 15 a number of companies found themselves in a situation where they did not have enough funds to provide their clients buying franc with profits. According to the regulation of “capital adequacy” they are not allowed to continue providing services any longer. “Huge debts” of loser clients are not considered by the regulation.