The Dominion Post
Forex flap reveals embarrassingly loose elastic
EXCHANGE rate controls are like bungee cords. The more they’re stretched, the more likely they are to suddenly ping back and take your eye out.
The Swiss should have known that and Chalkie reckons there must have been quite a few muttered ‘‘told you so’s’’ on the Borsenstrasse when their euro control had to be abandoned last month.
As the Sage of Omaha once said, you can see who’s swimming naked when the tide goes out. In this case the sudden withdrawal of the currency waters left numerous forex traders flapping on the mudflats and exposed unflatteringly loose elastic on New Zealand regulatory togs.
The Swiss National Bank’s decision, announced on January 15, meant the Swiss franc would be allowed to strengthen beyond its previous limit of 1.20 francs to the euro. The results were nothing short of spectacular as the exchange rate rapidly powered to 0.85 francs to the euro.
No doubt the Swiss had been tipped off about the European Central Bank’s pending monetary cattle prod, which was ultimately announced a week later.
That decision meant the ECB would pump new cash into the European economy by printing money and using it to buy euro area government bonds, a move that would inevitably weaken the euro.
Arguably it was no great surprise the ECB would act because the European economy was as lively as a Luxembourg tax investigator after a long lunch, so the bungee on Switzerland’s currency control could ping at any time.
However, it caused mayhem in the netherworld of online currency trading.
Chalkie is mystified by the appeal of forex trading. To judge by comments in online forums, private forex traders are often guided by astrological charts which signal buys and sells according to the phase of the moon in pluto.
Even the pros are bad at forecasting exchange rates, as most of them would happily admit.
Anyway, despite the odds, forex trading seems to be increasingly popular because offers of trading facilities online are proliferating.
One of those facilities was Excel Markets, set up by Americans David Johnson and Jason Peterson.
The two based their previous businesses in Florida, but this time set up Excel with its main contact centre in Ireland, a corporate entity in Auckland called Global Brokers NZ and a subsidiary in Cyprus.
The ownership of Global Brokers was held, equally, by two anonymous companies in the British Virgin Islands.
Until the Swiss bank did their thing last month, Global Brokers made not a ripple in the local water. But then we learned it was unable to resume business because some clients didn’t have enough money in their accounts to cover their losses from trading the franc against the euro on that tumultuous day, forcing those losses onto the company.
Chalkie should point out here that Global Brokers has so far returned at least 96 per cent, or about $1.9m, of the money it held on clients’ behalf and the company appears to have dealt with the situation properly.
However, the Swiss affair, aka francogeddon, revealed some loose regulatory oversight and the opacity of forex trading services.
Why Global Brokers chose to register in New Zealand is not clear – its principals have not been available for interview since its collapse – but Excel Markets described itself as a futures dealer ‘‘tightly regulated’’ by the Financial Markets Authority.
It appears Global Brokers was authorised to deal futures by the FMA on November 28, 2012, and opened for business in March 2013.
A condition of its authorisation was that it file audited financial statements to the Companies Office and to the FMA, as if it were an issuer of securities.
As we now know, this was not done. No statements were filed to the Companies Office until after Global Brokers went bust and it appears none were filed to the FMA until it applied for a derivatives issuer licence under a new regulatory regime late last year.
So despite being ‘‘tightly regulated’’ Global Brokers was allowed to ignore an important requirement of its regulator.
Chalkie reckons this was not a trivial oversight. Despite its name, Global Brokers was not a broker, in the sense of being a middleman between two transacting parties, it was a provider of contracts for difference, or CFDs.
According to its disclosure statement: ‘‘All products offered by GBL are not deliverable and you do not own the underlying asset. Instead, you are trading a ‘‘contract for difference’’, which is an agreement that allows you to make a profit or loss from fluctuations in the price or rate of the contract you are trading.’’
These contracts were between clients and Global Brokers directly, which means clients were reliant on the continuing solvency of Global Brokers.
Effectively Global Brokers was an issuer of securities and should have been treated like one as indeed its authorisation explicitly required.
Digressing momentarily, Chalkie notes that Global Brokers was also on a list of companies flagged by the Companies Office as required to file financial statements under foreign ownership rules. However, it turns out the registrar decided it didn’t have to because it was not a subsidiary of a foreign-owned company. Why not? Because a subsidiary has to have a controlling corporate owner and Global Brokers was owned 50/50, so was technically not under either company’s control. How did the registrar know the two British Virgin Islands companies weren’t under common control? It just took their word for it.
Phew that’s tough. Maybe it’s no wonder an American/British Virgin Islands/Irish/Cypriot securities firm wants to set up in New Zealand – our easy-going ways make our rules so much less burdensome. No worries mate.
Moving right along, the contractual nature of CFDs puts importance on the terms of the contract.
Global Brokers was one of several online trading outfits to suffer fallout from francogeddon. Others affected to a greater or lesser degree included Saxo Bank, IC Markets, CMC Markets NZ, FXCM, IG Markets and Alpari.
Here in New Zealand, Chalkie heard from one client of CMC Markets who lost more than $50,000 after being on the wrong side of the Swiss franc/euro cross.
His problem was not that he had rashly neglected to set up a stop-loss trade to cover his downside – he had. Although long on the franc, his position should have closed out if the franc strengthened to CHF1.199 to the euro and limited his loss to around $1500.
Also, perhaps anticipating what might happen if the currency peg was withdrawn, he had set up an opposite trade to make money if the franc moved to 1.197 and beyond.
His problem was that CMC executed neither of those trades.
Although its trading platform appeared to have executed the stop loss and quote prices during the franc’s headlong rush, CMC said the next day it had cancelled all trades during the most volatile period because there were no reference prices in the market. The client’s position was finally closed at 1.0082 francs to the euro, apparently the next available quoted price on the underlying market.
As Chalkie understands it, CMC was able to do this under the terms of its service because francogeddon was a ‘‘circumstance outside its control’’.
Fair enough – CMC appears to be within its rights under the contract. But Chalkie reckons this loss of 50 large ones shows firstly that forex trading is a mug’s game, secondly that traders can’t rely on any transactions they think they have arranged on a CFD platform, and thirdly that they should read the small print. As traders and regulators should know – this forex stuff can really hurt.
Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter