How Swiss Shock Humbled the King of Leveraged Currency Trading

(Bloomberg) — Drew Niv was looking for action. Then action came looking for him.

While in his 30s, Niv built his young brokerage, FXCM Inc., into a money machine by turning the global foreign-exchange market into a playground for day-traders.

But by early 2014, his hot hand had gone cold. Niv’s customers — small-timers who usually lost money while FXCM was busy making it — were looking for thrills elsewhere. Currencies seemed boring.

So from his 50th-floor office just south of Wall Street, Niv, now 41, held out a solution. FXCM could help customers capitalize on minuscule currency moves with a powerful financial tool: leverage.

Niv made no bones about the risks. Yes, leverage could amplify profits, he said. But it could also amplify losses.

“Leverage is the enemy,” Niv said in an interview with Bloomberg News in May 2014. “The big move, it’s what kills you.”

Well, the big move just arrived, via Zurich. The Swiss central bank’s decision to let its national currency float freely against the euro has blown a $225-million hole in FXCM and left Niv, its chief executive, struggling to contain the damage. Turns out, the leverage he’d warned of just eight months ago magnified his customers’ bets by as much as 200-to-1.

Shares Plunge

FXCM, the largest brokerage of its type, now ranks among the biggest losers from last week’s surprise move, which sent the Swiss franc soaring against the euro. FXCM’s share price plunged as much as 92 percent before trading was halted and Niv had grabbed a financial lifeline from Leucadia National Corp.

The Swiss-inflicted damage at banks and investment funds is still being tallied. But FXCM’s reversal of fortune has laid bare the risks Niv’s firm and its more than 230,000 customers were taking. Niv and New York-based FXCM didn’t respond to requests for comment.

For most retail investors, trading currencies through brokerages like FXCM is a fool’s game. About 72 percent of customers lose money, according to the National Futures Association.

Still, until now, FXCM tended to win even when its customers lost. In disclosure statements mandated by the U.S. Commodity Futures Trading Commission, customers are told upfront that such currency trading isn’t carried out on regulated exchanges.

Higher Leverage

“WHEN YOU SELL, THE DEALER IS THE BUYER. WHEN YOU BUY, THE DEALER IS THE SELLER,” the CFTC warning reads in capital letters. “As a result, when you lose money trading, your dealer is making money on such trades.”

Yet the Swiss shock also exposed the dangers this sort of trading can pose to the likes of FXCM. While the CFTC limits leverage to 50-1 in the U.S., most of FXCM’s retail customers are overseas, where regulators allow leverage of as much as 200-1.

The less money customers put down upfront when trading, the more perilous that trading can be for brokers. Margin requirements are like thermal shields on spacecraft: the thinner they are, the less protection they provide.

The 157-page prospectus for FXCM’s 2010 initial public offering warns of the disaster that could follow extreme market volatility, as happened last week.

“We may be unable to close out customer positions at a level where margin posted by the customer is sufficient to cover the customer’s losses,” the prospectus says.

Negative Equity

Many businesses might sue customers who refuse to pay up. Not FXCM.

The prospectus goes on to describe what, in hindsight, might seem like a weakness in FXCM’s business plans: “Our policy is generally not to seek to pursue claims for negative equity against our customers.”

In other words, if customers run up big losses, FXCM will be on the hook.

Niv, who co-founded FXCM in 1999, has guided the brokerage through tough times before. In the interview with Bloomberg last May, he recalled how the 2005 collapse of Refco Inc., then the largest independent U.S. futures broker, threatened FXCM. At the time, Niv’s firm got 40 percent of its business via Refco, which owned roughly a third of FXCM.

“We were idiots,” Niv said. “We didn’t understand the concept of concentration risk.”

Refco was a big, reputable firm, yet it collapsed in scandal. “All of a sudden, Boom! They blew up,” Niv said.

Hedging Trades

Amid the Refco troubles, FXCM established a different business model, acting as an agent for some customers with what it calls its “no-dealer desk.” Under this model, FXCM doesn’t take the opposite side of customer trade, but hedges its exposure with a bank or other market maker. In last week’s wild trading, FXCM apparently wasn’t able to close out its customers losing on Swiss franc trades in time to avoid swallowing their losses.

The CFTC has tried to make retail currency brokers safer. In 2010, the commission imposed a $20 million net capital requirement, weeding out small players.

There’s still plenty of risk. Unlike stock or futures brokerages, retail foreign-exchange firms don’t have to keep customer and firm money segregated in separate accounts. Instead, they can commingle the funds. So if a firm goes under, investors have no priority in bankruptcy and their money isn’t protected by the Securities Investor Protection Corp.

Who gets into this market? Niv described FXCM’s typical client as a male, white-collar professional between 35 and 60. “They want to trade as a hobby, and often aren’t allowed to trade at work,” he said in May. Unlike in the stock market, the currency market allows for online trading 24 hours a day, five days a week. “FX, you can do it in the middle of the night, you can do it after dinner,” he said.

Casino Gamblers

Many ordinary investors who trade currencies are a bit like casino gamblers: they may think they’ll win, but the odds are they won’t. Aite Group LLC, a Boston-based consulting firm, surveyed retail foreign-exchange traders in 2011 and found only 11 percent expected to lose money. Forty-one percent expected to earn monthly returns of more than 10 percent.

To keep such players from getting in over their heads, the National Futures Association has banned the use of credit cards to finance currency trading in the U.S., effective Jan. 31. According to FXCM’s 2013 annual report, 29 percent of its customers worldwide used plastic to fund their accounts.

But leverage — and all its associated risks — remains a powerful force in this market. On Monday, with the aftershocks from Zurich reverberating, FXCM’s U.K. website said the firm was still offering customers leverage — at 200:1.

To contact the reporter on this story: David Evans in Los Angeles at [e-mail] To contact the editors responsible for this story: David Gillen at [e-mail] Steven Crabill