Bad News for Investors: Systemic Risk Is Back on the Table

By Markets Fool.com


Currency broker FXCM suffered big losses yesterday. Image source: FXCM.

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Investors breathed a sigh of relief on Friday morning, with stock markets climbing after benign inflation data and oil-price stability gave market participants some added confidence going into the weekend. As of 1 p.m. EST, the Dow Jones Industrials were up 106 points, and the S&P 500 had climbed back above the 2,000 level. Yet even though the markets mostly behaved well to close out the week, the Swiss National Bank's recent decision to allow the Swiss franc to appreciate against the euro has sent shockwaves throughout the currency-brokerage industry. That niche market may not seem like a big deal, but it raises a much larger concern: Pockets of instability in various financial markets still pose systemic risks that can have a much wider impact.

How FXCM got franc-ed
This morning, trading in shares of currency broker FXCM was halted after shares dropped 88% in pre-market trading. FXCM issued a press release last night saying that because of "unprecedented volatility" in trading between the euro and the Swiss franc, "clients experienced significant losses and generated negative equity balances owed to FXCM of approximately $225 million." As a result, FXCM said, "the company may be in breach of some regulatory capital requirements."

Sometimes currency trading isn't this simple. Image source: FXCM.

FXCM wasn't the only company to feel the heat of the wild currency swings yesterday. New Zealand's Global Brokers NZ was forced to shut down entirely, and several European currency-traders estimated losses in the tens of millions of dollars. Elsewhere in the U.S., Interactive Brokers said that customer losses exceeded the amount they had on deposit with the broker by about $120 million, sending the stock down as much as 11% early in the day, though it has since recovered to a loss of just 2%. Yet given FXCM's small size -- the company had a market cap of just over half a billion dollars before the slide -- the potential hit could be devastating to its ability to keep operating.

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As we've seen in past financial-market events, industry peers sought ways to mount a rescue effort. Reports that Leucadia National's Jefferies Group subsidiary might offer a capital contribution of $200 million could be enough to help FXCM comply with regulatory requirements, giving it time to figure out how to collect now-delinquent customer accounts. Yet the longer-term problem is whether those unpaid amounts will be collectible at all, given FXCM's emphasis on helping retail traders who were likely completely unprepared for such a massive swing. Jefferies was involved in a similar bailout of market-making firm Knight Capital Group and therefore has experience with the issues involved.

Of greater importance to investors, though, is the fact that despite regulators' efforts to put some controls on the financial markets, they haven't eliminated the potential for unexpected events like the Swiss currency move to wreak havoc on various components of the financial system. So long as the potential for disruption exists, investors will have to be ready for seemingly unlikely risks that could balloon into crisis events in the future.

The article Bad News for Investors: Systemic Risk Is Back on the Table originally appeared on Fool.com.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Interactive Brokers and Leucadia National. The Motley Fool owns shares of Leucadia National. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.