The EU bailout in Cyprus and the forex and binary brokers

Article originally appeared on Leaprate.

More than 48 hours have passed since the (misguided) proposed EU "rescue" of Cyprus was announced, along with the planned taxation (or rather, confiscation) of up to 10% of bank deposits in the country. Since then, virtually all of Cyprus' forex brokers and binary options brokers -- and there are many -- have been scrambling to assure clients that their funds are indeed safe.

However we are still uncertain exactly how this confiscation will be applied, if at all -- as of Tuesday evening Cyprus' parliament roundly rejected the bailout plan, as long as it continues to contain any confiscation of bank deposits. And if the market hates anything more than bad news, it is uncertainty.

But this IS certain -- Cyprus, and the financial services companies operating in Cyprus, will never be the same. Whatever ends up happening, once the banks in the country reopen (the "bank holiday" in Cyprus has been extended until at least Thursday, possibly longer) we expect a flight of capital from Cyprus as well as from other perceived "weaker" EU countries, in favor of perceived safe havens (the UK, Germany, the U.S.). And that does not bode well for the forex and Binary Options brokers operating in the country (such as Iron Fx...).

The forex and Binary Options brokers in Cyprus are really dealing with two problems:
    Perception
    Reality

Let us explain. First, perception. As we wrote above, no matter what ends up happening here with the Cyprus bailout, it will be difficult in the near future for forex and Binary brokers, asset managers, and all other manner of financial services companies in Cyprus which hold client money to attract new customers and deposits. It won't matter whether those companies physically hold all their client funds abroad, as many do (an example being FxPro). They will be fighting an uphill battle for a long time. For this reason, whether deserved or not, we expect many of the smaller forex and Binary brokers in Cyprus to either close, or to formally move to other EU countries, mainly Malta or the UK. This should hit the nascent Binary Options industry really hard, as so much of it is centered in Cyprus.

The "Reality" problem which Cyprus forex and Binary brokers are already dealing with is actually fairly simple. If the EU rescue plan goes ahead as is (or even slightly modified), then very simply those forex brokers which kept client money (as well as their own funds) in Cyprus will wake up to find 10% of those funds missing. And those brokers who kept most if not all of client funds at banks abroad will likely be totally unaffected -- except they'll still be struggling with the "Perception" problem above.

So who escapes unscathed and who gets hurt? Based on our analysis, most of the larger and regulated forex brokers in Cyprus, such as FxPro (a member of LeapRate's Approved List) do indeed keep most if not all of client funds outside the country, with Tier 1 banks such as Barclays, Credit Suisse, UBS and HSBC. Also, those firms like FxPro which operate on an "agency" basis (as opposed to market-makers) are required to deposit a large portion of client funds with their Prime Broker, again usually a Tier 1 bank abroad. Firms like FxPro, and their clients, should not be hit at all by the proposed confiscation. And even if they were -- e.g. if some client money was indeed kept in Cyprus -- we believe that the forex brokers with sizable, strong balance sheets will make efforts to make their clients whole.

The problem will lie with the smaller forex and Binary brokers, and there are many, who kept client funds in the country. While they may have good intentions, those smaller brokers without sizable balance sheets (and whose own cash may have been partially confiscated as well) will simply not be able to make their clients whole.

Why did some (many?) brokers keep their clients' money in Cyprus? Interest. Big banks in London, in today's low-rate environment, simply pay no interest on deposits. But smaller, more aggressive Cypriot banks do pay interest, to attract depositors. Many smaller brokers were enticed by the "free" interest they could earn on their clients' deposited funds, ignoring the risks involved in keeping client funds at smaller, weaker banks.

However this shakes out, we believe that the Cyprus forex and Binaries scene will not be the same. It will shrink. Smaller, weaker brokers will leave and/or fold. Some of the larger ones may decide to relocate to the UK, Malta or elsewhere as well. And an industry which employs directly about 5,000 people on the island and a lot more indirectly will employ a lot less.

Again, this episode is far from being resolved. As of this writing Cyprus' parliament rejected the bailout, the ECB reiterated its intention to "provide liquidity" under existing rules for the time being, and the banks in Cyprus remain closed.