SNB Crisis Anniversary: Glenn Stevens on What is Yet to Change

As the Swiss National Bank induced crisis hit the industry last year, one of the brokerages that managed well through it was GAIN Capital. Finance Magnates spoke with the company’s CEO Glenn Stevens on the matter of how things have developed and what is yet to come for the foreign exchange brokerage industry.

Speaking about the changes that have happened over the year, Mr Stevens said: “There are micro and macro perspectives to look at what has changed throughout the past year. From a macro perspective the SNB event was the kickoff to a round of increasing volatility in many markets. While they are not necessarily linked to jointly form a contagion effect, from an event perspective the domino has started about a year ago.”

We still have quite a few participants that are not institutionalizing or truly embracing the value potential of managing risk

“The on/off switch keeps flipping for the past years and we are seeing periods of high volatility take turns with quiet market conditions. We haven’t seen a fall off a cliff yet, although one could argue that in the case of the EUR/CHF somebody turned on the switch and all hell broke loose,” he elaborated.

The value of managing risk

With the obvious need for more market risk management, changes at some brokerages happened, however according to GAIN Capital’s CEO those haven’t been enough: “We still have quite a few participants that are not institutionalizing or truly embracing the value potential of managing risk. Spending the time, effort and energy on doing different scenario testing like for example testing what would happen if the Chinese market moves limit down 7 per cent.”

“A number of markets nowadays are tightly interlinked and if a broker is not offering a Chinese equity index for example, that doesn’t mean that its Chinese yuan or Japanese yen books are insulated from a rapid stock market decline in China,” Mr Stevens pointed out.

While some companies have embraced substantial changes to their modus operandi, others have not, and in the long run, this is what will matter. Mr. Stevens said that he doesn’t believe that we have seen a widespread adaptation of a feel for companies thinking outside of the box and anticipating prospective risks.

“Many of the moves we took at GAIN Capital in the run up to the Swiss National Bank (SNB) event were taken a year and a half or even two years before the 15th of January 2015. The severity of the event and the timing were surprising to us, but not the fact that it happened,” he explained.

A year later, I am still surprised of the lag that exists for real change to happen to a market

“Some brokers ended up on the wrong side in the situation because they thought that they know what is going on in currencies. A year later, I am still surprised of the lag that exists for real change to happen to a market. I don’t believe that we have seen the full fallout from the SNB event just yet.”

The full changes to the market are yet to come

Speaking on the prospects for future changes to the market, Mr Stevens said: “We still see policies and procedures continuing to unfold at banks, regulators and retail brokers alike. The structural changes that I thought would have taken a couple of months are taking longer. I think it will take an additional six to nine months to see the full effects of the crisis.”

“Part of that is the concept of the prime brokerage model. It depends on which end of the spectrum one wants to start to look at the issues. If we look from a central bank’s perspective, they might introduce some changes to the banking business, which will trickle down to institutional clients and brokers and will ultimately affect the trading conditions of the retail traders,” he elaborated.

With the prime brokerage business turning into a penny per million business, further changes to the market are inevitable

Mr Steven certainly has a point on the PB business, he further explained: “With the prime brokerage business turning into a penny per million business, further changes to the market are inevitable. A broker used to need about a million to be able to maintain a credit line with a prime broker, now it needs 50 million. That definitely changes the landscape its just that the rollout of the issue is smooth, rather than a sharp one.”

“We saw at least a five years trend of the services of a prime broker’s service getting cheaper and cheaper reversing as a result from the SNB event. Banks realized that they totally miss-priced certain risks and the time for changes has come. Risk management issues may force some banks to outsource some of this risk.”

We asked Glenn Stevens whether he thinks that next time it will be more difficult for b-booking brokers to manage their risk during a black swan event, and he was happy to elaborate on the matter: “The SNB event could have just as easily went the other way, which is why I was trying to explain to people that in the case of GAIN Capital, it wasn’t like we were on the right side of a trade or we were lucky.”

“In our case a series of advance testing and modeling showed how we could minimize a major impact. It was a combination of having option coverage, having a portion of the risk b-booked, having a portion of the risk minimized just by making good old-fashioned reduction of the books. By having a higher margin requirement on the Swiss franc we have reduced the amount of the risk on our books,” he explained.

Stevens concluded on the matter: “The event didn’t prove which model of running a brokerage is better, what it did prove is that black swans happen for a reason and its all about how one prepares for it.”

Banks are very unhappy with the current state of the market, and the possibility for spreads increasing is actually present. We haven’t seen an expansion in the bid/ask for years and this might actually be the first year that we start to see a little bit of a pushback. The bid/offer spread is supposed to reflect the costs involved in a transition. One of the costs involved is to book the trade, hold it and provide margin for it. While we may not see prime broker prices go up, we may see the bid/offer increasing.

What should brokers do to optimize their risk practices?

Mr. Stevens certainly has massive experience in the foreign exchange markets world, which is why he was the go to person for us to ask questions about risk management. Asked about what should brokers do to optimize their risk practices he explained: “Brokers need to embrace the concept of risk management and that means going through the processes of considering impact from risk events and taking actions to protect themselves from those. If we look to the SNB, we have made changes to our book 6 to 9 months before January 15th.”

“Managing risks has to be one of the top priorities on a broker’s list along with marketing, technology and compliance. I don’t think that many brokers have embraced the practice of managing their market exposure risks,” he continued.

In conclusion, the CEO of GAIN Capital said: “Brokers need to raise the estimates of the capital required to be in this business for the long haul. Too many venues are underestimating the changes that may come to the business. If there is a way to attract additional capital, that should be part of the mix for a broker.”

Blitz questions:

Will we see more prime brokers in the industry or fewer? – Fewer

Will non-bank liquidity providers become an alternative to prime brokers? – Yes, they will continue to emerge and will become more sophisticated.

Will we see higher spreads in major currency pairs a year from now? – Leaning towards a yes

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