Sucden Financial’s Michael Davies explains the importance of managing counterparty risk in FX

The fifteenth of January two thousand and fifteen.

Saying those words evokes memories of a day of extreme uncertainty for many, and the end of the road for some. At the very best it is an all encompassing reminder of a day which transformed the landscape of this industry, whether the firm concerned was a technology vendor, a retail broker, or indeed, a prime brokerage.

Counterparty risk is a subject which rose to the forefront of the agenda for many companies following this event, however the stable door was wide open and the horse had long since run for the hills by the end of that particular dark day, with negative client balance exposure in the hundreds of millions of dollars across the industry.

One reason that counterparty risk has become a very critical point for examination is that many retail FX firms put faith in their Prime of Prime (PoP) broker, understanding that all order flow and risk management would be effectively outsourced and conducted by that entity. After a year of low volatility, the Swiss National Bank created a storm akin to raising a spinnaker in a force 9 gale, which not only saw the end for many retail firms, but also some PoP brokers as there was not enough collateral at hand to be able to manage such a sudden bout of market turbulence in the vast majority of cases.

Today, Andrew Saks-McLeod, CEO of FinanceFeeds was at Sucden Financial’s London headquarters, where an important insight could be gained into how to structure a company which can weather any such storm. Michael Davies, Senior Sales Manager at Sucden Financial explained to FinanceFeeds “The SNB event highlighted just how important it is to consider the financial strength of the counterparties a broker works with. Those companies with weaker financials were not able to withstand a financial blow that the large CHF move caused for many.

“Going forward it is essential to consider whether the liquidity provider a broker works with is able to survive an extreme market event. We have been surprised at how many Prime of Prime brokers seem to have only a few million dollars of capital, which would hardly leave them capable of surviving even a relatively small loss. Sucden Financial has a capital base of over $100m and is part of an even larger group, Sucres & Denrées, a global market leader in physical commodities, employing over 4000 people in over 30 locations around the globe” said Mr. Davies.

“Post SNB the banks and Prime Brokers are reviewing the financial strength of many of the companies they are working with and are continuing to cut the facilities of many of their broker clients who do not meet their ever increasing minimum capital requirement.”

“In addition, the banks are not just considering the financial strength of the companies they provide liquidity and prime brokerage services to, but also how diversified they are. At Sucden Financial our FX business is highly diversified, in that we provide liquidity to a wide range of different types of clients.

Actually our 30 year history in Institutional FX started by providing FX services to the large physical commodity related companies” said Mr. Davies.

Vital solidity and reliability bolstered by vast physical resources

Mr. Davies detailed that the related physical companies include large multi-national producers and consumers of physical commodities like mining, agricultural companies and manufacturers. In fact, although FX is a large part of Sucden Financial’s business, exchange traded derivatives is actually still their core business. This diversification is considered to be extremely positive to both their banking partners and clients alike. They believe that there is a huge risk of selecting a smaller prime of prime liquidity provider who could be at risk of losing access to the banking services they are so dependent on.

“One final point which I would like to expand upon is that not only is it important to consider strength of the counterparties you use for liquidity, but also the quality of the clients you take on board” detailed Mr. Davies.

“At Sucden Financial counterparty risk takes priority over commercial considerations. Sucden Financial has a Credit and Risk Committee, at which the financial strength of every counterparty we work with is considered, including every client we provide liquidity to as well. We have always set hard limits on the amount of exposure we have to any client based upon their financial situation and not just on how much money they hold with us. When you consider that it was actually the trading activities and losses of clients over the SNB event that caused financial difficulties for many brokers, you can see just how important this is.”

“It certainly seems as if many more brokers since January 15th are starting to consider counterparty risk more seriously as well. Although we always asked for audited financial information for every client we opened an account for, before the start of this year we were rarely asked for our financial information. Now though, many clients we bring on board ask for this information. We would strongly suggest that a broker obtains financial information on any new LPs they want to work with and also from their existing relationships, so that they put counterparty risk at the forefront of their decision making process” he concluded.