In 2011, the Swiss National Bank (SNB) introduced the exchange-rate peg, which capped the value of the Swiss franc at 1.20 per euro. However, on Thursday 15th January, the SNB suddenly announced that it would no longer hold the franc at a fixed exchange rate with the euro. What followed was global turmoil, which brought many FX brokerages to their knees.
In order to understand why the SNB suddenly decided to uncap the franc against the euro, we first have to look at the recent history of the currency. Many investors consider the Swiss franc, along with US sovereign bonds, as a “safe haven” asset. Furthermore, the Swiss government is generally viewed by investors as secure and unlikely to make waves in the markets. As a result many investors from all over the world flocked to the franc. The knock-on effect of this was an increase in the value of the currency, which is exactly what the Swiss government did not want, as exports comprise 70% of GDP. To combat this and bring down the value of the currency, the SNB decided to create more francs and use them to buy more euros. This in turn caused the value of the franc to fall relative to the euro, whilst simultaneously amassing the SNB a foreign-currency reserve in the region of $480 billion.
With this in mind, we ask ourselves: (why did the SNB make their recent decision?) According to numerous reports, the leading reason was to prepare for the European Central Bank’s introduction of “quantitative easing”, with discussions being held this Thursday on its implementation. This would require the purchase of government debt from Eurozone countries, which would affect the value of the euro. A possible result would be the SNB having to print additional francs to maintain the cap they put in place in 2011. Additional reasons have been put forward: Some commentators have argued that there was growing political discontent at the vast foreign-exchange reserve which the SNB had amassed, highlighting that it could potentially lead to hyperinflation. Second, due to the euro depreciation in 2014, the franc (being pegged to it) also suffered, losing 12% of its value against the dollar and 10% against the rupee.
What happened to the markets?
Following the announcement the franc surged against the euro by 41% against the euro on January 15th (the biggest gain on record) climbing by at least 15% against more than 150 other currencies.
The devastating effects on financial institutions were felt globally. The most well-known casualty so far has been Alpari UK, which entered into insolvency in the immediate aftermath and has since closed its doors. According to sources at the firm, the SNB’s decisions created “exceptional volatility and extreme lack of liquidity” and left the firm exposed to huge losses. Other notable casualties included FXCM, the largest U.S. retail-foreign exchange broker, who were left with customers owing them $225 million and have since entered into a financial agreement with Leucadia, the holding company of Jefferies Group LLC. IG markets took a £30 million hit, whilst Excel Markets and Global Brokers NZ ceased operations.
Losses were not just felt amongst the FX community. Global Tier 1 institutions, mutual funds and hedge funds all suffered losses, with Marko Dimitrijevic’s Everest Capital Global Fund being completely wiped out.
Aftermath
Since the announcement the markets have begun to stabilise, with the euro rising 2.5% to 1.01 francs on Friday 16th January. However, the true ramifications of this decision are still to be felt, with the Swiss economy and their own financial institutions likely to bear the brunt for the foreseeable future. UBS has already downgraded its forecast for Swiss growth in 2015 from 1.8% to 0.5% and many Swiss banks have already voiced their fears over money flowing to other countries. KPMG, brought in to run Alpari UK, have already stated that they have received inquiries from potential buyers, with aim of preserving the business and jobs as far as possible. However, the lasting impact of the SNB’s decision will not be known for many months to come, but may well be vindicated and ultimately praised if quantitative easing has the desired effect on the Eurozone economies which the ECB are hoping for.