One of the world's safest investments — the Swiss franc — has swung wildly this week after the central bank in Switzerland announced it would scrap its policy of limited the rise of the currency.
It may seem like an arcane move, but it's not. The Swiss National Bank's surprise decision on Thursday caused the franc to surge against the euro and dollar, sending shockwaves through the global financial system.
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Holders of Swiss francs profited handsomely, but many investors and brokerage firms, were pounded with losses. Two brokerage firms in London and New Zealand's have announced huge losses and will have to close. A New York-based currency broker said clients suffered significant losses, and needed an emergency loan to stay in business.
The turmoil is all the more unsettling because, like U.S. bonds, the dollar and gold, the Swiss franc has been viewed as a haven for investors, thanks to the stability and wealth of the Swiss government.
Here's what happened to the franc and why it matters?
How did we get here?
Since 2011, the Swiss National Bank has had a program to keep its franc from appreciating too much against other currencies — most importantly the euro, says Ian Gordon, a currency strategist with Bank of America Merrill Lynch.
The franc's rapid rise makes goods and products produced in Switzerland more expensive and less competitive in other countries. The bank set a limit of 1.20 francs to the euro to keep its rise in check.
So what happened next?
After several years, it became untenable for the Swiss National Bank to keep up its program. The euro was continuing to weaken against other currencies, notably the dollar, and the European Central Bank was likely to start stimulus programs that would weaken the euro even further.
The SNB decided to allow the market to re-price the franc Thursday. This caused a massive re-pricing of the currency that led to the franc to gain more than 20 percent against the euro.
Reserve currencies do not move like this, so a 20 percent move in the franc was considered historic, investors said.
How did the Swiss Bank's move hurt banks and traders?
Because currencies don't usually move much in a single day, traders often use significant leverage to boost their returns. Leverage of 50:1 is not unheard of in the currency market.
Because the franc is heavily traded, the SNB's decision reverberated throughout other currency markets and caused abnormal moves. This left traders exposed to massive losses. Anyone who had bet against the franc, even just a little bit, was hit.
Where the losses likely happened were in euro. Here's an example: A trader invested $100,000 in euros and borrowed 19 times that amount as leverage, or $1.9 million, for a total investment of $2 million in euros. The 5 percent decline of the euro against the dollar Thursday would have created a $5,000 loss for the investor's money and a $95,000 loss in the leveraged money. The investor would have lost everything.
Reports also emerged that the SNB's move inflicted big losses on the some of the world's biggest banks. The Wall Street Journal reported both Citigroup and Deutsche Bank had lost more than $150 million in the turmoil following the bank's decision.
Mark Costiglio, a spokesman for Citi declined to comment on the report, as did Deutsche Bank spokeswoman Renee Calabro.
Why are some brokerages folding?
When investors borrow money as leverage, that leveraged money has to come from somewhere. In this case, it came from the brokers where these clients had accounts. Any losses that exceed a client's balance would have left brokerage firms exposed.
New York-firm FXCM said Thursday that the movement of the Swiss franc generated "negative equity balances" of $225 million, meaning its clients owed FXCM $225 million. It is likely that FXCM will have difficulty getting back most of that money. FXCM had to get an emergency $300 million investment from Leucadia National to stay in business.
Other brokers said similar things. New Zealand brokerage firm Excel Markets said, "when a client cannot cover their losses it is passed onto us," which left Excel without the capital they needed to operate.
Does it matter to stocks and bonds?
Swiss stocks were hit hard by the currency moves. When a country's currency gains in value, it makes goods made in that country more expensive on the global market. Swiss manufacturers now have products that are 15 to 20 percent more expensive than they were three days ago — making it more difficult for Swiss companies to compete.