Investing overseas is up, but are brokers segregating client funds safely?

Mitigating risks while making a profit is what banking is all about, but banking on a global scale tends to escalate risk parameters on a geometrical basis, something we often forget at our own peril. The recent crisis in Cyprus has shaken the forex industry to its collective knees. Government officials have seized client deposits. A once thriving global financial center is in disarray, and the forex trading industry is valiantly attempting to repair its tarnished image.

While the primary impact has been on the operations of a portion of the forex brokerage community, the secondary impacts will surely befall those banks that had them as customers offshore. The nature of the risk problem had nothing to do with currency trading. The Bank of Cyprus and the Laiki Bank, the two largest banks on this tiny island in the eastern Mediterranean, had invested well above prudent levels in Greek bonds and had suffered enormous losses, as a consequence. Bailout agreements dictated that account holders at these two banks with accounts in excess of 100,000 Euros pay the price, a hefty 40% “haircut” by some estimates.

Sovereign risk or poor investment decisions by a bank in another foreign jurisdiction can arise immediately, leaving little time to react. In this case, the Bank of Cyprus will be re-structured, but the Laiki Bank will be shut down. Of the eighty forex brokers on the island, the ones with foresight and that followed “best practices” retained customer deposits in segregated accounts with offshore Tier-1 banks. Their clients can rest easy, but other brokers are scrambling to raise new capital, be bought out, or close down permanently, leaving someone else, either individuals, creditors, stockholders, or bankers, to absorb immeasurable financial losses.

Monitoring the risks that might bring down a global brokerage firm is not an easy task. Counterparty risk is amplified when multiple jurisdictions are involved. As much as we would like the European Debt Crisis to dissipate, its consequences keep popping up, not only in the European region, but also in other overseas jurisdictions, as well. The situation in Cyprus may only be the tip of the iceberg. There may be similar scenarios where other banks have overindulged in national bond offerings or their clients may have done the same in high-risk overseas stock offerings.

Fund managers have recently been touting foreign stocks, once again. Fidelity is just one example: “Most international markets have rallied along with the U.S. market. For instance, Japan’s Nikkei has risen nearly 20% in 2013, and even many of the developed European nations that are so embroiled in the sovereign debt crisis are solidly in the green as of mid-March. While U.S. stocks have surged out of the gate—the S&P 500® is up roughly 9% year to date—investors might want to keep an eye on international markets that may be able to provide global growth opportunities.”

Investors.com also noted this week that, “About 10 highly rated foreign stocks have broken out of bases in the past few days — a bullish development for international investors. The rash of breakouts indicates a significant shift to foreign stocks.” Risks, however, still abound – country-specific risk, currency risk, Geo-political risk, sovereign risk, and different accounting standards also muddy the waters.

The time may have passed to prevent the potential impact of these risk factors upon your brokerage client base, but at the very least, it would be wise to check if each client does follow best business practices. Do they segregate customer account balances safely offshore, away from local officials that might seize these funds for other purposes?

About the author:
Tom Cleveland has had extensive background with the foreign exchange market through developing his visa system and expanding its global reach while serving as CFO for various Visa International entities from 1980 until 1999. Mr. Cleveland started to commentate about the foreign exchange market through forextraders.com in 2009 and his recent forex broker 2013 overview page can be located at http://www.forextraders.com/forex-brokers.html