Swiss franc surge knocks out brokerages, roils financial markets
Jan 16, 2015
By: Pete Evans
Swiss franc surges 30 per cent after central bank ends artificial cap designed to prop up euro
A day after the biggest single-day move for a major currency in modern memory, the shockwaves of Switzerland’s move to end its euro peg continued to reverberate Friday.
On Thursday, the Swiss Central Bank ended its three-year policy of pegging the value of the Swiss currency, the franc, to the euro. Since 2011, the bank has pledged to never let the value of the euro dip below 1.20 francs. It achieved that by buying up euros, which pumped up the euro’s value and held the franc’s value much lower than it would have been, if left to free market forces.
Switzerland has long been seen as a safe haven, a good place to keep money during fearful times. In many ways that’s a good thing for a country, but it actually hurts exporters because it makes their goods and services — in Switzerland that’s things like chocolate, watches, pharmaceuticals and ski vacations — a lot more expensive for foreign customers to buy.
The Swiss central bank managed to keep up the policy for years, but in recent months, the pressure driving up the franc became too great, as Europe’s economic prospects took a turn for the worse and investors fled to the safety of the Alpine nation’s economy. Russian money also played a major role, as wealthy Russians rushed to convert their devalued rubles into as many francs as they could get their hands on.
When the bank removed the peg, it opened the floodgates.
“It was a bigger move than when the USSR collapsed, it was bigger than when George Soros bet against the pound, and it was even bigger than 9/11, in terms of the currency markets at least,” said Karl Schamotta, director of FX research at Cambridge Mercantile Group.
Derek Halpenny, a currency strategist at Bank of Tokyo-Mitsubishi UFJ, described the currency move as “unprecedented.”
When the artificial lid was lifted, the franc soared. It was up by about 30 per cent almost immediately, before ending the day up 15 per cent. Anyone who happened to be on the wrong side of that trade — holding too many euros, and not enough francs — suffered heavily.
The Swiss stock market tanked, down nine per cent on Thursday and four per cent more on Friday. Swiss bank UBS lost 15 per cent of its value. Switzerland’s 10-year bond yield was -0.03 per cent, meaning an investor would have to effectively pay to lend money to the Swiss government.
Small brokerages went bust
While big banks can absorb large, sudden losses, for some smaller firms, the volatility in the franc proved too much.
Alpari, the London-based brokerage firm that sponsors the shirt of English Premier League football club West Ham United, said it had to shut down its business.
In a statement, the firm said the majority of its clients sustained losses which exceeded their account equity. “Where a client cannot cover this loss, it is passed on to us,” it said. “This has forced Alpari (UK) Limited to confirm today that it has entered into insolvency.”
Alpari’s demise follows that of Global Brokers NZ., a small currency trading house in New Zealand.
Its director, David Johnson, announced on the website of affiliate Excel Markets, that it could no longer meet the regulatory minimum to continue business.
“News of the impact of this event on companies and traders is just beginning to come to light,” he said. “As directors and shareholders we would like to offer our sincerest apologies for this devastating turn of events.”
The two could be joined by FXCM, a New York-based currency broker, which has already warned that it “may be in breach of some regulatory capital requirements” after its clients experienced significant losses. Those losses, it said in a statement, “generated negative equity balances owed to FXCM of approximately $225 million.”
Fighting the tide
It was a painful lesson for those firms, but a reminder for other central banks that currency pegs rarely work — especially for big economies, Schamotta said.
“Few central banks have ever decided to intervene in a market like that and for good reason — you’re fighting against the tide,” he said. Any short term gains to be had from the strategy are usually offset by pain down the line when the peg has to be lifted.
“The history of currency pegs is that they are susceptible to changes in economic fundamentals that warrant a completely different level in the exchange rate,” said Neil MacKinnon, global macro strategist at VTB Capital.
As Schamotta put it: “Central banks are designed to lean against the wind, not tilt at windmills, and maintaining the euro peg became impossible.”