FXCM’s Condign Comeuppance: It Lobbied To Retain 50:1 Currency Leverage

We’ve the news that FXCM, the retail foreign currency trade broker, has managed to find itself some capital to keep it afloat after the fiasco it had with the Swiss Franc.

Good, lovely and all that, not that retail FX trading is really something that anyone should be trying to encourage. That doesn’t mean it should be banned either, nor even more regulated but it’s really not something that retail investors should be doing. The deep pockets are those of Leucadia National LUK +0.92%, who also own Jeffries. Their stock rose on the news so at least someone’s happy with the deal even if it’s not the stockholders of FXCM.

However, there’s one detail in this story that is just oh so lovely:

In 2010, the Commodity Futures Trading Commission sought to force individual investors trading currencies to give their broker 10 cents in capital to back every $1 in positions. The regulator failed to accomplish that amid pressure from New York -based FXCM and other brokers, meaning only 2 cents must be pledged.

The agency’s proposal would “have a devastating impact on the retail forex industry,” Drew Niv, FXCM’s chief executive officer, wrote in a March 2010 letter to the CFTC that was signed by eight other executives at currency dealers. The industry relies on “electronic systems” to liquidate customer trades and protect against “currency fluctuations in the market,” they said in the letter, which is posted on the CFTC’s website.

It’s not entirely obvious that those higher margin requirements would have saved FXCM but still, that is fun, isn’t it? They lobbied against the rules that would have protected them.

So, just to gallop through the background here. So, there’s a large number of individuals trading foreign exchange. As above it’s not the most sensible market for retail investors to be playing in but there again, it’s their money and there’s no law, nor should there be, against losing your own money. The regulators are there to make sure no one steals it from you, sure, and to make sure there’s no systemic risks being taken, but that’s not the issue here. Capitalism does mean that you’re entirely at liberty to do silly things with your money from trading FX through that triumph of hope over experience, a second marriage.

But currencies don’t usually move all that much. A couple of basis points (0.01%) in a day for example. So, people leverage up. The maximum leverage permitted in the US is 50:1, which is pretty high, but there were foreign companies allowing up to 500:1 (which is insane and those companies are now bust). This isn’t, in normal times, a problem. There’s that 2% margin, if a trade is at risk of breaching that margin then the broker can and will close out the trade and, ooops!, the investor has lost all their money but the broker hasn’t.

Then we get that Swiss National Bank bombshell about the CHF/EUR limits and the price moves 40% almost immediately. No chance of those stop loss orders coming into play as the market simply wasn’t there to enable them. So, these accounts with 2% margins on them are now looking at 30% or more (the rate gyrated in the day) losses and it’s the broker that has to pick up the 28%.

Thus FXCM losing $225 million and having to essentially fire sale the firm at 10-14% of the previous day’s stock value.

There’s really no regulatory movement needed here. People just aren’t going to be offering those sorts of terms in the future. People do learn when the markets turn around and smack them across the chops. Margin requirements are going to be higher, leverage permitted a lot lower.

However, it’s just too sweet, isn’t it, that FXCM was one of those lobbying against the very regulatory change that might have saved the firm?

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via Forbes – This Is Just Too Lovely About FXCM, Just Too Lovely For Words.