From multi-million dollar losses to litigation. Why a lack of credit checking in the FX market is a clear and present danger

Over the last ten years the number of prime brokers in the FX market has halved and those that remain have significantly trimmed their client base, concentrating on better capitalised clients.

The reason is quite simple. The risk of suffering a significant loss from a defaulting client has not justified the returns for prime brokers. These losses not only happen through significant market events such as the SNB crisis but also after algos have lost control or where thin liquidity and electronic orders cause losses in the tens of millions of dollars.

The real issue is that credit is not allocated or managed correctly at trading venues in real-time and often the person with the credit risk is the last to know. Many of these risk systems sit downstream and are slow; some even require manual processes.

More worryingly, the latest solutions for managing a client in distress involves the use of kill switches, terminating market access. This actually increases risk as it locks the client into a bad position and moves the responsibility of closing the position to the prime broker who takes time to verify positions, often leading to significant litigation risk.

This is just one example of how the mismanagement of credit is negatively impacting the FX industry.

Against this backdrop, we recognise the pressing need for a low latency credit management solution built for modern distributed electronic markets, and in particular automated trading.

Cobalt has developed an innovative credit management platform that significantly reduces risk for FX market participants. Built for modern, distributed electronic markets and automated trading, our low latency credit management platform utilises high-throughput technology to control credit and associated market access rules throughout the trade lifecycle in real-time. It significantly reduces risk for the entire FX market, without disrupting the traditional means of execution.

Crucially, the platform is co-located amongst all the main execution venues, meaning it is fast and operates a high throughput messaging infrastructure that can guarantee the delivery of over one hundred thousand messages per second.

Credit can be managed using all traditional market methodologies: NOP, DSL and most importantly margin. It can be pushed dynamically to clients and trading venues in real-time, meaning that a client in a distressed situation cannot increase their position but is able to unwind it and eliminate the risk.

This is critical during unpredictable market events and in instances where algos have lost control, or where thin liquidity and electronic orders can cause losses in the tens of millions of dollars.

Electronic trading has evolved beyond recognition in recent years, and it’s now critical that credit management catches up. Centralised, low latency credit management is the future for the global FX markets and Cobalt is leading the charge in creating a more efficient, orderly future for all participants.