Why Did Some FX Brokers Become Insolvent and Some Not?

This article is written by Ron De Luca who is a senior risk analyst at Mercer Capital Ltd., a NZ regulated forex brokerage.

An unexpected announcement by the National Bank of Switzerland (SNB) to de-peg the Swiss Franc from the Euro caused the Franc to climb approximately 40% in a matter of minutes. Many currency brokers who seemed like solid companies became insolvent or were at risk of regulatory issues due to lack of capital requirements. These companies included FXCM and Alpari. I will explain how the proper Risk Management Risk Management One of the most common terms utilized by brokers, risk management refers to the practice of identifying potential risks in advance. Most commonly, this also involves the analysis of risk and the undertaking of precautionary steps to both mitigate and prevent for such risk.Such efforts are essential for brokers and venues in the finance industry, given the potential for fallout in the face of unforeseen events or crises. Given a more tightly regulated environment across nearly every asset class, One of the most common terms utilized by brokers, risk management refers to the practice of identifying potential risks in advance. Most commonly, this also involves the analysis of risk and the undertaking of precautionary steps to both mitigate and prevent for such risk.Such efforts are essential for brokers and venues in the finance industry, given the potential for fallout in the face of unforeseen events or crises. Given a more tightly regulated environment across nearly every asset class, Read this Term of a forex brokerage could have prevented this.

When the SNB made the announcement, many investors that were short on the Swiss Franc received margin calls. Under normal market conditions, the brokerage can exit the trades with their Liquidity Liquidity The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent Read this Term providers at will. In this case, the market moved so rapidly that the brokers were not able to exit the trade when their clients had margin calls. This led to crippling loses for these currency brokers.

Most STP (straight-through processing) brokerages segregate client funds in one way or another and have an equal amount of money aggregated in the banks providing their liquidity. This event proved that having client funds 1:1 at the clearing banks is insufficient.

The brokerages that weathered this crisis and came out as industry leaders are the ones that had more than the total sum of their trader equity allocated to the liquidity providers. This is not the regulatory capital requirements which can’t be used by the broker for operations, but rather a percentage of broker’s profits that remains by the liquidity provider. Some brokerages have 2:1 ratios while others have as much as 3:1. In this scenario, the broker will sustain losses in such a drastic moving market, but not enough to seriously affect the operations of the brokerage.

(correction: an earlier publishing of this post erroneously included OANDA with FXCM and Alpari as struggling brokers when in fact they had only suffered losses and weren't near breach of their capital requirements)

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