Reading the judgement on the latest leg of the legal action brought by CFH Clearing against Merrill Lynch over SNB-day activities five and half years ago, I find myself thinking that neither party comes out of the affair particularly well. On one hand we have a customer executing without due care and attention; on the other a bank refusing to adhere to market practice and then following that up by ending the prime brokerage agreement in double quick time so that it could, I assume, draw a line under the entire matter.

In the weeks following the SNB debacle I was, regular readers will be surprised to hear, rather vocal and opinionated, and a big part of my problem was how we arrived at the 0.85 low in the first place. If I recall correctly, EBS consulted with its major clients and the result was 0.85, something I wasn’t happy with because I had been told of large volume being transacted at 0.70 and lower. Effectively, 0.85 was a number, not so much plucked out of the air, but designed to satisfy the most number of market participants. In relation to the events of that day, however, it was pure fantasy, and this is the problem that led to CFH and Bank of America no doubt spending huge sums on lawyers over a CHF 2 million claim. My understanding remains that the “official” low is established when a certain volume and/or number of trades are executed at a particular level – why was this custom thrown out of the window on January 15 2015?

I suspect the answer to that question is to keep some firms alive – it is also a reflection of the common sense that exists in – but largely left on that day – the FX market. The thing is though, why have rules if they can randomly be changed? I don’t think any rational person would have looked at the events of that day and thought “yes, I think the euro is totally worthless now” – but that is what the price action told us on that day when, as I noted, the euro was at one stage worth less than one sixth of what it started the day at. That is the type of price movement that only exists when the Eurozone ceases to – did anyone really think this was a euro problem?

0.85 was a number, not so much plucked out of the air, but designed to satisfy the most number of market participants…In relation to the events of that day, however, it was pure fantasy

Whichever way you look at it, if EBS had followed the rules, the “official” low would have been much, much lower, and, incidentally, the traded low would have been at the subliminally ridiculous 0.00125. Had that happened, we would probably have had more casualties but we would not have had yet more legal actions – it’s for each individual to decide which outcome they think is best.

A related issue here is the blending of retail and institutional markets. Whilst I think the vast majority of people on that fateful day absolutely knew the rate was wrong, the selling was by algos, who largely don’t think, they hit; and by retail brokers revaluing their clients’ portfolios at silly rates, rates that existed for seconds or minutes at the most. I don’t think there was anyone out there who thought EUR/CHF would end the day at those levels, so why not hold off on liquidating the clients’ positions? If the clients themselves sold EUR/CHF that is their problem, they would have panicked and paid the price; but to liquidate on the back of margin calls in such an event? Frankly, by the time the margin calculations had been made and the trades actually confirmed the market was probably back above 0.5 on its way to 1.0 – the latter being a very sensible stopping point.

I also think that, as the judges noted in their judgement, CFH could have put a price limit on the sell orders, but didn’t. One can easily imagine how that happened, with perhaps an inexperienced person panicking, or, as noted, blindly following the rules. It’s sad, but whose fault is it really that the firm didn’t protect itself and its clients’ orders in a better fashion?

Looking at the role of Merrill, I am not surprised that the bank took until the next day to re-paper the trades, others took as long, some longer, but I am surprised that it decided to step out of line with most others in selecting 0.75 – this was a course bound to end in conflict. In spite of my belief that the 0.85 level was silly, I do feel the bank failed to do what most observers would consider to be “the right thing” morally. Perhaps it wore the risk at the low levels, as any sensible trader would have done (and many did on that day) and offloaded it at 0.75? I am not sure we will ever know that.

I also don’t think it’s a good look when the bank terminated the prime brokerage agreement the following day, or used its disclosures as a defence against the claim. Yes, legally I think the right decision has been made, but the disclosures were probably of the sort that saw me well and truly stuffed by Malaysia Airlines recently. As the judges note, market practice obligations are “inherently uncertain” when the trades are subject to ISDA agreements and the platform being used to disclosures.

ACI’s Model Code, which was the only real source of market conduct guidelines pre the FX Global Code was cited by the judges, specifically the piece about off-market rates. This was indeed one of the areas focused upon by CFH in its argument. The trouble is, and I think the Model Code got it right by the way, actually deciding what is an off-market rate in a circumstance like this? If we have a trade that creates a new traded low multiple big figures away from the last and the market reverts back then yes, I think we can all agree it is an off-market trade and could be re-papered. When hundreds, perhaps thousands, of trades are executed all the way down to 0.00125, how can trades at rates between 0.14688 and 0.20111 be considered off market?

The day the SNB pulled the plug remains an event that is shrouded in sadness, awe and disbelief, but events like this also serve to remind us that there is one final party doesn’t come out of this well, the Swiss National Bank itself. This is what happens when you try to manipulate exchange rates and exit that strategy badly and with few obvious thoughts to the consequences. The closure (assuming there is no further appeal) of this case only highlights what an awful job the central bank did that day – a statement that is backed up by the fact that more than five and a half years later the ramifications are still being felt.

Like I said, no one in this case has come out of it particularly well…except the lawyers…again!!

Twitter @lamboPnL


Colin Lambert

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