Retail foreign exchange ripe for consolidation post-Swiss shock
The retail FX market is ripe for further consolidation as brokers that successfully navigated the volatility of the Swiss franc cap prepare to swoop on strugglers that took a hit, says the CEO of US forex broker Gain Capital.
The Swiss National Bank’s (SNB) decision to abandon its currency cap on the Swiss franc caught brokers by surprise, and resulted in a number going bust or scrambling to find the funds to stay afloat.
UK forex and spread-betting firm Alpari collapsed, while US broker FXCM had to accept a $300 million two-year loan from holding company Leucadia National Corporation, which also owns investment bank Jefferies, after its share price fell more than 80% in pre-market trading.
Glenn Stevens, chief executive officer at Gain Capital, said the firm emerged unscathed from the Swiss franc disaster and actually generated a trading profit, and is now on the hunt for acquisitions.
“There are a fair amount of consolidation opportunities – some of them are driven from dire straits [and] some are just an extension of where the market is going already,” he says.
Gain Capital has already made six acquisitions in the past 18 months, including Global Futures & Forex and UK firm City Index, as part of its expansion plan.
We started to identify a potential for lack of liquidity
“We’ve been pretty active so ultimately that puts us in a position to act quickly because we have a template [in terms of] resources, the ability to price deals and make a credible bid,” says Stevens. “If an auction scenario or dire-straits discussion comes up, we are very well prepared.”
Javier Paz, senior analyst at consultancy firm Aite Group, also predicted industry consolidation due to decreased trading activity, as brokers impose higher margins on customers and some go out of business. He estimates there are about 450 retail FX firms worldwide. In terms of global retail FX volume, Aite estimates that gross trading volumes in 2014 were $413 billion per day.
“Outside of Japan and the US, I’d say that there could be maybe 5% decrease in activity,” he says. “As a result of this we will [see] some consolidation and maybe a handful of transactions taking place as a result of this SNB move.”
Gain Capital avoided the same fate as some of its competitors by correctly identifying the binary risk posed by the EUR/CHF floor as early as last summer: if the SNB maintained its 1.20 floor, all was well. But if it chose to abandon it, all hell would break loose, a prospect that ultimately materialized.
“Globally, EUR/CHF was treated as a very liquid product like EUR/USD or USD/JPY,” says Stevens. “But we started to identify a potential for lack of liquidity or a more violent move which, in our mind, created a second set of risk parameters that didn’t exist with major currencies.”
He drew a comparison with emerging-market currencies such as the Mexican peso or Russian rouble - they have a different set of rules and requirements to major currencies and, as such, require a different risk-management strategy.
Stevens sat down with the company’s head of risk management, Tim O’Sullivan, to address the potential risk challenges of the EUR/CHF currency pair and, by November, had ramped up its customer margin requirements fivefold.
Customers that traded using leverage to maximize their returns were hurt the most by the SNB move. Regulators, including the US National Futures Association, are now examining whether to impose stricter caps on leverage.
However, Stevens believes the key is investing in better risk-management policies, and monitoring potentially risky events on the traditional bell curve. “Blue moon” events are unlikely to happen, but they are not impossible and should not be ignored, he says.
“The tails of the bell curve are the building blocks of risk management,” he says. “You look at these unlikely outcomes – that is where it’s valuable to pay attention and be pro-active.”
According to the most recent BIS Triennial FX survey, $185 billion (3.5%) of the $5.3 trillion average daily FX volume for April 2013 was classified as retail flow.
Customers cannot simply rely on stop-loss orders to stem their losses when currency markets experience gap events, such as the SNB move, because liquidity dries up and brokers cannot fill market orders.
Paul Chappell, founder and chief investment officer at currency management firm C-View, predicts a change in investor attitudes.
“We will see changes in investor appetite for currency management – people shying away from those managers running naive carry strategies – and moving more towards diversified portfolio managers who employ relatively less leverage so there is less concentration risk”, he says.
Nik Bienkowski, co-chief executive officer of exchange-traded product (ETP) provider WisdomTree Europe, believes investors wishing to bet on currency markets using leverage should consider less risky alternatives, such as ETPs.
“Most are fully collateralized and, with an ETP, you can’t lose more than your initial investment,” he says. “You can only go to zero.”