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Higher FX margin rates could be sign of things to come

Higher margin requirements imposed in the run-up to the Brexit referendum could be a sign of things to come as the FX market digests the impact of reduced leverage

Margin rates are driven by a variety of factors, including historic volatility and liquidity, and the wider macroeconomic backdrop.

Many FX brokers increased margin rates and reduced leverage and trade size in an effort to minimize the impact of large currency movements in the run-up to the UK’s referendum on membership of the European Union on June 23.

Oanda, for example, advised clients about the risks of trading in an environment that was likely to see extreme volatility – as well as raising margins. Saxo Bank raised margins on all sterling pairs and crosses to 7% in the run-up to the referendum. FXCM, which was badly caught out when the SNB took off its peg with the euro, also raised margin requirements ahead of the vote.

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 Chris Towner, HiFM

These actions appeared to pay off for Saxo Bank in particular, with the broker claiming that Brexit-related trading added around $220 million to the total value of collateral held by its clients during the three-week period of higher margins.

A spokesperson confirmed the bank raised margins on June 16 and normalized rates gradually over the following few weeks, with full normalization implemented on July 6.

Nenad Naumovic, chief dealer at forex broker BMFN, observes that disciplined traders usually reduce their trading size and exposure during periods of uncertainty.

“By changing their margin requirements and putting on new restrictions, brokers push all of their clients to be more cautious,” he says. “However, customers are not always pleased with these margin increases because they force them to reduce their trading size.”

The frequency of such increases varies. Naumovic notes that brokers could go more than a year without changing their margin requirements, but that volatility and surprises could prompt them into action twice in the same month.

Chris Beauchamp, senior market analyst at IG Group, acknowledges it is difficult to say how quickly margins generally return to previous levels after a market-shaking event, because every situation is different. In the case of the Brexit referendum, the reversion was swift.

BMFN’s Naumovic adds: “When we imposed a reduction in margin requirements and maximum trading size just before the EU referendum, we warned our clients weeks before the event and increased our margin requirements two days before the vote.”

Margins returned to normal levels immediately after the weekend following the referendum when the broker’s risk department determined that the market was normalized and liquidity had returned.

However, while there are situations where risks can be highlighted and diarized – such as elections and referendums – there are other occasions when there is an unexpected sharp rise in volatility, says Chris Towner, managing director at HiFM, an FX risk advisory firm.

“There are often aftershocks in the market after a large event has happened, so returning prematurely to normal spreads could leave the FX broker exposed,” he explains.

“It is interesting to note that in the 24-hour period after the EU referendum, GBP/USD dropped from 1.50 to 1.32, a 12% fall in the value of sterling. Going back over 10 years, the average range for a year in GBP/USD is just over 13%, so we saw pretty much a year’s volatility in just one day.”

Towner also notes rumours of FX brokers taking out insurance in the lead-up to the EU referendum or even pulling out of the market altogether. In this context, the impact of the higher collateral requirements imposed by a number of brokers in advance of the EU referendum should provide the market with some food for thought.

With Belgium’s Financial Services and Markets Authority, France’s Autorité des marchés financiers and the European Securities and Markets Authority all recently issuing warnings about excessive leverage, it will be intriguing to see whether brokers have the appetite for trying to convince traders that higher collateral requirements are in their long-term interests.

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