The casualties have been mounting in the wake of the decision by Switzerland's central bank to abandon the Swiss franc's (CHF) currency cap against the euro. In the immediate aftermath, the euro lost nearly a third of its value against the CHF - one of the most striking single-day movements ever between currencies of developed economies. The knock-on effects have already been wide ranging and, in some cases, calamitous. But it's difficult to predict how this issue will play out in the long-run. For instance, it is too early to say what effect the exposure of Eastern Europe's banks to Swiss-denominated debt will have on banks in the UK. At the risk of sounding alarmist, lesser shocks than this have derailed regional economies in the past.
The earliest casualty was UK spread betting firm (and West Ham United sponsor) Alpari, which was swiftly put into administration under special terms introduced in the wake of the Lehman Brothers collapse. So what went wrong? Foreign exchange speculators routinely find themselves exposed on the wrong side of currency movements, particularly when markets are volatile. That's the nature of the game; it's a binary bet, after all. But the sheer magnitude of the CHF appreciation, together with its rapidity, exposed serious flaws in Alpari's business model - and perhaps those of the retail spread-betting industry as a whole.
Apologists for the industry will point (with some justification) to rather erratic monetary policy on the part of the Swiss National Bank (SNB). For some time the SNB had been intervening in currency markets, ostensibly to keep Swiss manufacturers competitive and the exports flowing. It essentially boosted CHF liabilities in order to fund large-scale purchases of foreign currencies, principally the euro. The end result was upwards of CHF 260bn in liabilities mismatched with euro assets. Ergo, every time the euro fell, the SNB booked losses. With the prospect of eurozone QE looming into view, together with the attendant implications for the value of the single currency, the Swiss obviously thought it best to cut their losses. There is always fall-out from volatility in foreign exchange markets - remember the turmoil brought about by sterling's hurried exit from the European Exchange Rate Mechanism. But the ability of exposed industries to withstand such a jolt is bound up with the effectiveness of regulatory regimes.
Alpari was holed below the waterline because many of its clients who had taken leveraged positions in EUR/CHF trades were unable to meet margin calls covering their losses. In reality, Alpari's failure - and the vulnerability of larger entities such as CMC Markets, Saxo Bank and IG Group - is linked to questionable risk management controls, particularly with regard to leverage multiples.
The retail market now accounts for around a fifth of the average daily turnover of global foreign exchange dealing. This is perhaps unsurprising when people are scrambling for returns in a low-interest rate environment. For as little as £1,000, a retail punter can set-up an account where that initial commitment is used as collateral to magnify their currency bets; that initial stake could seed a £100,000 position. Often foreign exchange/spread-betting firms will cover their clients' losses well beyond their initial cash deposit. After all, where's the sense in your clientele only risking that which it can afford? Better to crank-up the leveraged positions to entice custom - and with it, your fee income.
Alpari was swiftly brought into administration to minimise any disruption to financial markets. But, of course, the horse had already bolted. Obviously ministers have been preoccupied with reforming the UK banking industry, but this latest episode reinforces the view that what the City needs rather less of is 'light-touch' regulation. The good news, at least for Alpari's clients who weren't on the wrong side of the trade, is that client funds were kept in separate escrow accounts in line with FCA provisions, so the administrators will be returning those deposits in due course.
