Analysis: What is the real cost? We have not seen the end yet

The Swiss black swan has far from flown away from the FX market as further distress has begun to emerge among publicly listed companies which are obliged to report their financials, and non-reporting OTC firms keep their cards close to their chest in vast numbers.

As proceedings at FXCM Inc (NYSE:FXCM)’s conference call on its earnings moved on to the effect of the Swiss National Bank’s removal of the 1.20 peg on the EURCHF pair on January 15, a glaring inconsistency emerged.

It was reported following the firm’s exposure to negative client balances that the total liability was approximately $225 million, however, following yesterday’s formal announcement, CEO Drew Niv explained “As many of you know, on January 15 this year, Swiss National Bank discontinued its currency floor for the Swiss Franc against the Euro.”

Mr. Niv continued to explain that “Our customers suffered significant losses which resulted in negative equity balances or debit balances as we call them, owed to us of approximately $276 million.”

The firm’s deal with Leucadia in which a $300 million capital financing program was entered, covers this and the firm has already completed $12 million in repayments however the terms include rising interest and a forced sale after three years.

On this basis, following the firm’s announcement yesterday, it is pertainent to pose the question as to what the full extent of the damage was to the entire industry.

As LeapRate reported just days after the Swiss black swan event, FXCM has now confirmed that it is beginning the process of selling its stakes in FastMatch, Lucid and V3 Markets.

FastMatch more than doubled its average daily volume for the entirety of December in just one day (January 15) during the sharp changes in the market caused by the Swiss National Bank’s removal of the 1.20 peg on EURCHF.

As FXCM looks to offload its 32% share in the company, FastMatch has demonstrated some highly profitable performance. To put this into perspective, FastMatch exceeded its daily average volume for December 2014 by 200% in one day, having handled $24.3 billion in buy and sell orders on January 15.

Mr. Niv yesterday gave a concise insight into the firm’s rationale for selling these units: “While smaller than Hotspot, FastMatch has grown much more rapidly. We believe its technology and architectue position to be much superior to Hotspot and the next leader in the FX ECN platforms.”

“Lucid has been one of the leading and most successful algorithmic market makers in FX and is expanding outside of FX. V3 Markets, our most recent acquisition is a high-frequency trader of primarily listed products in futures and options” stated Mr. Niv.

The dissenters who were quick to cast their dismal view of the likelihood of repayment will indeed be interested in the potential capital realization from these proposed sales.

Combining the three North American contingents with FXCM Securities in London, which is a small trading desk offering listed products such as futures and equities to UK customers, which is the legacy that the firm inherited from ODL Securities, Mr. Niv stated “We believe that the sales proceeds plus the cash freed from the balance sheet of these entities could exceed $250 million, which would go a long way toward, if not fully repaying, the Leucadia loan.”

Interestingly. former Lucid Markets principal Matthew Wilhelm has made several transactions during the course of the last year, cashing in tens of millions of FXCM shares that were provided to him at the time of FXCM’s acquisition of Lucid Markets. He began selling shares by liquidating $7.8 million of FXCM stock in 2012, followed by a further $8.6 million in March 2014, and another $4.3 million in October last year.

The largest sale of all was made by Mr. Wilhelm in January 2014, when he sold $19 million worth.

Mr. Niv made reference to Hotspot’s sale by KCG recently for $365 million in cash with a contingent tax payment of up to $70 million. This is a very interesting comparison, as KCG Holdings, Inc. Class A (NYSE:KCG), Hotspot’s former parent company, found itself reduced from a highly solvent, publicly listed conglomerate to a firm on bankruptcy watch after losing over $500 million in August 2012 as a result of a test algorithm having been erroneously connected to a production server, which then executed trades on a live market.

The firm took a $535 million loan from GETCO which makes FXCM’s $300 million deal with Leucadia pale into relative insignificance, however the firm repaid its commitment far ahead of schedule and is now prosperous, and even flush with cash after its sale of Hotspot FX to BATS Global Markets.

There is one major factor which differentiates the market conditions in which KCG returned itself to solvency compared to that of today, that being a period of high volumes during the summer months of 2013 across the entire industry which spanned for approximately six months, and that KCG was faced with an internal matter rather than an all-encompassing global event which has now blunted the performance of every firm in the market as margin requirements creep up and nervousness sets in among firms and their customers alike.

FXCM’s volume report for February showed a clear collapse in volumes which were down 41% compared with January for the firm’s retail business.

Compatriot and direct rival Gain Capital Holdings Inc (NYSE:GCAP) experienced a 20% drop in volumes in February, as did a series of venues and OTC firms across the globe.

LeapRate’s discussion with Saxo Bank COO Claus Nielsen last week indicated that there is more conservatism in store across the industry and that margins will likely become higher in anticipation of further volatility.

Meanwhile there is much trepidation about the future of the Euro, which is almost at parity with the US dollar, and the entire continent which the European Commission’s socialist policies have run into swingeing youth unemployment, vast, unserviceable external debt and low productivity as well as political unrest is a combination which does not bode well for the restoration of such a vast region’s economy to health, hence the likelihood of measures in the future being taken by independent nations with strong currencies.

Whilst Denmark kowtows to Europe, intentionally devaluing its own currency, Switzerland hemmed itself in and protected its status as a vault-like destination for traditional investment.

Therefore, the question on the minds of many executives across the FX industry is likely – “are we prepared?”

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