Swiss Cheese…or the Revenge of the Gnomes of Zurich…

Markets are still reeling from the effects of the Swiss National Bank’s (SNB) decision on 15th January to remove the peg between the Swiss Franc (CHF) and the Euro, with the concomitant further reduction in deposit rates to -0.75% almost incidental. To say that the move was unheralded and unexpected is an understatement. When two of the world’s reserve currencies move against each other within minutes by up to 40% (sic), it gives a new meaning to the term “gap risk”, and emphasizes how event risk is rightly the stuff of risk managers’ nightmares.

Of course, hindsight is a wonderful thing; and there are those now claiming that they foresaw such an event as inevitable. Perhaps so; but the consequences demonstrate that few, if any, expected what occurred. The SNB’s actions may have been unexpected, but they were not irrational, even if one might disagree with the supposed reasons, including concern about being a “one way street” and about a hugely inflating balance sheet.

As always, one now has to think about the medium- to longer-term impacts, in a world already grappling with the rapid fall in the price of crude oil; geopolitical concerns over the future of the Euro in light of the forthcoming Greek elections; signs of deflation in certain economies; and available spreads and margins that often do not reflect the real level of risk because of the actions of key central banks.

Already, there have been corporate failures in the FX broker market, seemingly because the companies involved, having allowed their clients significant levels of leverage and required modest levels of collateral, were “surprised” when those same clients, on the wrong side of a CHF transaction, were unable to cover their obligations, leaving the broker’s capital exposed.  News is also trickling out of possible hedge fund failures. These consequences just reinforce how effective risk management has to look at tail or extreme scenarios (assuming that it is proper to designate the SNB’s actions as such) and ask the “what if?” questions. As those defaulting have found, a single event can blow up your balance sheet or business in a matter of minutes; and leverage is always dangerous if it is not controllable. Just think back to the failure of LTCM, or the “certainties” of the “carry trade”!

However, the FX broker and hedge fund failures are merely “collateral damage” and unlikely to be economically important. Of much more concern are the potential impact on the export component of the Swiss economy; the hidden linkages in financial institution balance sheets; and the consequences for countries such as Poland and Hungary, where CHF mortgages have historically been quite prevalent.

At Awbury, we would not claim to have foreseen the timing of the SNB’s abrupt change in policy, but we would not have said it was in any sense a “black swan” event. The reasons for it are explicable and within the central banking “playbook”. However, as always, we will factor into our risk analyses for ourselves and our clients the likely consequences.

Now, where is that hunk of Emmentaler…?


-The Awbury Team


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