On January 15, 2015, the Swiss National Bank (SNB) officially abandoned its EURCHF minimum peg policy which had been in place since September 6, 2011. At that time, the SNB, worried about the increasing strength of the Swiss Franc and the negative impact this would have on Swiss exports (including tourism), had placed a minimum peg of 1.2000 on the EURCHF. The SNB had promised then to defend the peg vigorously. When that decision was made, the CHF currency pairs in the market saw significant movements in a space of 15 minutes, with generalized weakening of the CHF. The snapshot below shows the movement on the EURCHF on September 6, 2011 when the decision was announced.
When the minimum peg was abandoned, it caused a great upheaval in the forex market, with traders and brokers affected by the outcome of the decision.
Traders: Many traders had banked on the fact that the EURCHF peg would continue to be defended at the 1.2000 level. Despite the fact that there was heavy pressure at that level for several weeks leading up to the peg abandonment, many traders had long orders at or around that price level, with very tight stops set just below that peg. There had been occasions in the past when rumours of a further tightening of the peg or some news item that led to Euro strengthening, had caused the EURCHF to go as high as the 1.2472 mark. Knowing that this 250-pip band had been achieved in the past, many traders were as it were, “all in”, with very little attention paid to risk management. Many of these traders were also operating with very high leverage and little of their own margin, and sustained huge losses which exceeded their account capital as a result of the slippage which occurred and the inability of brokers to cover the stops on those trades. Some brokers are now trying to recover the negative balances from their traders.
Brokers: Many retail brokers have always offered their clients very high leverage to the order of 500:1, effectively allowing their traders to trade with as much as 500 times their own committed capital. This led to a situation where many brokers which were not very well capitalized, over-extended themselves with the leverage capacity. When the peg was abandoned, the bottom literally fell out from under the bucket. Massive slippage occurred with the EURCHF tanking by almost 3,500 pips. This sent many trading accounts into debit as their stops could not be covered by the brokers.
The ability of brokers to curtail trading losses via issuance of margin calls to affected accounts also led to significant losses on broker accounts. Presently, Alpari UK and Excel Markets have been declared insolvent while several other brokers have taken steep losses. Only a few brokers who saw the writing on the wall and cut their leverage provision on CHF pairs to 10:1 were spared.
Many of these losses would have been avoided if traders and brokers alike had fully understood the market fundamentals that led to this move.
Why the SNB Abandoned the EURCHF Peg
How did the SNB get to the point where it was forced to eat its words after promising to defend the minimum peg aggressively?
Maintaining the peg involved the SNB having to sell hundreds of billions of Swiss Francs, and buying the Euro in exchange. In other words, the SNB would flood the markets with Swiss Francs, leading to an oversupply situation, while acting as a Euro buyer of last resort. The supply pull on the CHF would also extend to other CHF pairs as well, causing a generalized weakening of the Swiss Franc.
The essence of this move was clear: to make the Swiss Franc cheaper relative to other currencies and promote Swiss exports. Tourism for instance, is a major income earner for the Swiss economy. During winter, many tourists hit the ski resorts and tourist centres for holidays. A cheaper Swiss Franc would mean that tourists from Europe and the US can exchange their Euros and US Dollars for more Swiss Francs than they would have been able to, allowing them greater spending power while in Switzerland and other Helvetica territories.
However, a number of market fundamentals began to challenge the peg heavily in 2013/2014. One of the challenges to the peg was the seemingly unending Eurozone sovereign debt crisis. The anti-austerity Syriza party came to power in Greece and threatened to completely unwind all actions and agreements entered into as part of the Greek bailout package. Faced with continued pressure on the Euro, the European Central Bank was forced to announce a quantitative easing package which would see a very massive bond buying program that would further depress the value of the Euro. These factors made the cost of defending the EURCHF peg increasingly unsustainable for the Swiss National Bank, leading the bank to finally jettison the peg in January 2015.
Some market analysts had seen this coming as far back as October 2014. Dukascopy, a Swiss-based forex brokerage, had predicted the abandonment of this floor in an October 2014 article on its website, taking a proactive move to reduce the leverage on CHF pairs to 10:1, thus reducing the exposure of its clients and its own exposure as well. Gain Capital, Saxo Bank, RoboForex and Admiral Markets also reduced their leverage on CHF pairs before the SNB decision.
Going Forward
It is now evident that the words of central bankers are not set in stone and that the only thing that is constant in the forex market is change. Change in policy and changes in market fundamentals can happen at any time in the market and can lead to very adverse consequences on traders and brokers alike. The fallout from the SNB tsunami underscores the importance of risk management as a tool for capital preservation and survival in the market.
It is very likely that we will see situations where risk management teams of brokerages will get a lot more proactive in the application of leverage. The Commodities and Futures Trading Commission (CFTC) had already mandated US brokers to set leverage of forex and options positions to 50:1 and 20:1 respectively as far back as 2010. While other brokers may not be as strict with their leverage and margin requirements, it is likely that brokers will no longer shy away from reducing leverage on currency pairs which are deemed to pose a slippage and negative balance risk to traders and brokers by extension.
Traders should also realize that they are their own first line of defence when it comes to slippage risk. Losses due to slippage can be minimized by proper position sizing and by use of manageable leverage amounts. It is hoped that all concerned can learn the right lessons from the SNB event of January 15, 2015.
