Discussion panel: Is the A book here to stay post Swiss franc event?

The metaphorical return to the drawing board with regard to risk management in the retail FX industry begun in mid January, as a direct result of the Swiss National Bank’s removal of the 1.20 peg on the EURCHF currency pair.

On January 15 this year, the rapid appreciation in the Swiss franc as a result of this decision caused previously well capitalized brokerages to be exposed to negative client balances, some of which managed the losses, and some of which did not and are now insolvent.

Today, at the FXIC Latin America conference hosted by Shift Forex in Mexico City, Nick Mortimer, Head of Prime Brokerage and Clearing Solutions at CFH, Mushegh Tovmasyan, CEO of FCA regulated Divisa Capital, and BMFN VP of Service and Support Bernardo Martinez spoke in detail with Shift Forex CEO Ian McAfee about the way in which brokerages and liquidity providers must now adapt their execution model to combine aspects of A book and B book methodology in order to mitigate risk.

Mr. McAfee posed a question in order to find out what the repercussions are toward brokerages and liquidity providers, and how the entire ecosystem must now evolve.

Mr. Tovmasyan began by explaining “This was an unprecedented event, we have never had such a dramatic move, it caught the brokers, prime brokers, and liquidity providers, all at once. I answered the phone and the message was that the world is ending! This was a wake up call for everyone to assess their risk management.”

“We are in a leveraged industry, which is a double edged sword, this can help or go against a company” he said.

Mr. Martinez further explained “We are talking about this event constantly, as I am sure is everyone in this industry. A black swan can happen at any time, therefore all traders should always be prepared for the worst. That way no traders accounts will be blown, and brokers will still be alive. We actually made a good profit out of this, and saw it as an opportunity rather than a disaster. I understand that some got into a difficult situation, but it is still hard to understand that such devastating effect can happen in one day.”

“My advice to traders is to know your partners, know your IBs, and brokers, start making better relationships with them. Ask them questions on what they are going to do to prevent any catastrophic events in the event of any other black swans” said Mr. Martinez.

Mr. Mortimer then concurred with Mr. Martinez. “Yes, I agree” he said. “It proves that your liquidity provider needs to have partnerships on the other side. Always ask where he is getting his liquidity from.”

“Our risk management got stress tested in extreme conditions, and some banks were quoting through this, which came as a result of relationships with banks, that we have had for years. If you are an STP broker which we are, these relationships are vital and can ensure that the a-book model can be kept stable.

Mr. McAfee then explained the evolution that the industry has experienced gradually from the B book model toward A book. “Now we can see that a few A book brokers got wiped out, whereas the B book who took the risk, made a big profit. There is now a question: Is B book now safer than A book, int hat if you have debt to your clients and the clients go negative, you have on one side a strong relationship with the liquidity, on the other side negative balances to customers. What do you think? how will the model change in future?”

Mr. Martinez answered by stating that “Even though this is kind of a trick question as there is no good or bad answer, I would say that a combination of both is a good method, where the broker can take on some risk when the margin is ok or when expanding, and then release that risk on an A book basis when necessary. Brokers should make it known to clients whether they are A booking or B booking.”

Mr. Mortimer continued by explaining: “I like the A Book model, I signed a piece of paper with the FCA to say I cannot take any risk. Do I want to be A Book right now? There was probably some opportunities to run risk, but we are A book which is one of our USPs, because of reduced rejection, certain execution speed and reliability, and no internalization. Right now, youre right, the model going forward is to run some A book, some B book, however we have to carry on as A book because thats our model.”

“I think we will not see consistant spreads, but there will be more of a conversation about spreads, credit, and margin rates. How is a broker going to pass on order flow that carries increased margin rates? Right now we are trying not to, but I understand that there are certain brokers that are discontinuing pricing out on list of currencies that are pegged, many pairs that are pegged are stopping because they are A book brokers and they cant work with that differential.”

“The difference has become spreads and credit, whereas before January 15, it was what could be offered, now it has all changed. I am an A book broker, thats it! However, I agree that if we could we would like to run some risk at this point in time” said Mr. Mortimer.

Mr. Martinez then replied by saying “: You might be able to earn more money and give clients more service,” to which Mr. Mortimer said “You are right!”

Mr. Tovmasyan then continued the dialog by explaining “This is a zero sum game, one dollar lost is the other side’s game. Looking back, it is hard to suggest that we could have said its best to be A book or B book. If your balance sheet is not enough to last through one week, or one month, or one year of losses, then this is not the right model for you. However, if risk management is done well, then it is sustainable. Divisa Capital has signed the same paper with the FCA that we are an A book broker, but we do stand in the middle and can see from banks and hedge funds, each has a different risk model, and clients have a different risk approach.”

“We provide liquidity to B book brokers who then create their own risk management. The job of a top tier bank or prime broker is to create the best form of liquidity and make it so that their brokers can choose how it is executed” said Mr. Tovmasyan.

Turning to the events of today and our convening in Mexico City, Mr. McAfee asked “Some tend to target, some less energy on this market here in Mexico. What do clients need to succeed in Mexico and in greater Latin America?”

Mr. Mortimer answered “A key word that has been used alot today is education. From our point of view, in Latin America we haven’t even scratched the surface. We have 2 experts looking at the area, and we will create liquidity for this particular area.”

“It seems to methat there are a number of brokers here whose client base is not Mexican. The retail brokers perhaps go ‘offshore’ to trade with such brokers, therefore there needs to be more advertising to get the retail guys to come on board in Mexico” opined Mr. Mortimer.

Mr. Tovmasyan’s perspective on this particular matter is that he has “been in FX for 10 years, and have seen market interest vary from region to region. It is down to marketing to a certain degree, for example there is a part of establishing an industry sector which involves lobbying regulators, whereas other matters are viewed from a risk perspective. Someone needs to take the first steps. I can compare Mexico and some of Latin America to China for example.”

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“There is alot of wealth among the middle to upper class people, and whilst Mexico has a good regulatory structure among banks, there are no regulations to make any FX activity illegal or not illegal. Brokers have invested heavily in China, and now millions of dollars are spent in marketing and entering that market, which has triggered the existance of money managers, an IB network, marketing and support” continued Mr. Tovmasyan.

“I don’t think enough money is being spent here. Everyone considers it an important market for the future, but they don’t invest. There is alot of financial services in other asset classes, a wealthy middle class potential client base, and little competition or bureaucracy” stated Mr. Tovmasyan.

With regard to platform choice, Mr. Tovmasyan added that he considers that the MetaTrader 4 platform is here to stay. Mr. Mortimer, agreeing with Mr. Tovmasyan, stated “I agree, MetaTrader 4 is here to stay. At CFH however, it is not about front end platforms. What I think this year, especially after the events of January 15, taking a variety of front ends and being able to do risk management on one platform is paramount.”

“We have to give the clients the choice – if a client calls and wants MetaTrader 4, you have to provide it, if they want a different platform you have to provide it.”

Mr. Mortimer concluded the discussion by looking ahead: “What we would like to do is put all of the trading functionality into one platform that manages risk, therefore it is not about hte front end, but the components behind it. That is what is most important for 2015.”

Photograph from left to right: Nick Mortimer, CFH. Bernardo Martinez, BMFN. Mushegh Tovmasyan, Divisa Capital. Ian McAfee, Shift Forex.

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