Currency floor breach raises questions over SNB policy

A controversial breach of the Swiss National Bank's (SNB) minimum exchange rate for euro/Swiss franc on April 5 - and the ongoing testing of the minimum rate this week - has raised questions among traders over whether the SNB should adjust its procedure for enforcing the minimum rate.

According to a memo sent to clients by interdealer broker Icap on April 5, the EBS platform printed a market low of SFr1.19900 to the euro at 09:41 GMT that day, despite the SNB's policy - implemented in September 2011 - to keep the spot rate above 1.20. A number of eligible trades are understood to have taken place below the minimum rate, due to the SNB not having credit relationships with some banks trading the pair.

"Following a thorough investigation of the participants and market action at the time, EBS can confirm the low was printed due to the lack of bilateral credit relationships between a number of market participants. EBS confirms all trades are good trades and that normal trading conditions existed on the EBS platform throughout," said Icap, which runs the EBS platform.

It is unclear exactly how many counterparties traded euro/Swiss franc below 1.20, but some traders believe it could have been as many as seven, prompting speculation that the SNB's policy of buying unlimited quantities of euros to enforce the minimum rate may not be as effective as it could be. Some participants have suggested the central bank should consider enlisting the help of the top-tier banks to protect the currency floor.

"If I were a central bank protecting a certain level, I would bid myself and then go to the biggest banks with the best credit rating and ask them to bid for me at certain levels. Those banks are more used to being active in the market, and their credit files are as big as they possibly can be, so they could provide a lot of support for the floor," says the head of foreign exchange trading at one European bank.

"This does raise questions about the SNB's method of executing," says the head of spot trading at a second bank in the UK. "If it spreads its bids around the market with between three and 10 of the top banks, then it's very unlikely people would hit below the peg, because as you increase the number of counterparties bidding on your behalf, you reduce the likelihood of people not having credit loaded with one of those counterparties."

The SNB has resolutely defended its commitment to enforcing the currency floor, but in a detailed statement on April 10, Thomas Jordan, vice-chairman of the SNB's governing board, recognised t has no control over the activity of those banks that "cannot or do not wish to trade with the SNB".

"Each bank has its own individual group of counterparties, and, in particular, banks with lower ratings only have a small number of counterparties. The exchange rates below Sfr1.20 per euro were concluded by banks that do not have an agreement relating to limits with the SNB. Banks that sold euros for less than Sfr1.20 did not receive the best market price and had - relatively speaking - to accept losses. Since there is no compulsion to make business transactions at the best prices, such anomalies cannot always be excluded," said Jordan.

The SNB has credit relationships with more than 100 banks, Jordan added, which means the global foreign exchange market is "almost completely covered", but he stopped short of discussing any potential changes to the SNB's procedures for enforcing the minimum rate.

Speaking at the FX Invest Europe conference in Zurich earlier this year, Martin Schlegel, the SNB's head of foreign exchange and gold, robustly defended the central bank's policy on the minimum rate as a matter of credibility that was necessary to support the Swiss economy, adding that it had so far been "quite successful". Schlegel declined to comment for this article.

The euro/Swiss franc exchange rate has remained close to 1.20 since April 5, and was trading at SFr1.2017 to the euro at 10.34 BST this morning, according to data from Thomson Reuters. In a research note published yesterday, Deutsche Bank warned the pair is likely to remain close to the minimum rate, with a possible unwinding of positions as the SNB continues to defend the floor.

"Our positioning indicators point to record speculative shorts in the Swiss franc, implying the unwind of these positions may be large. We don't think the floor will break, but an unwind of the speculative long may mean ranges become even tighter, with euro/Swiss franc staying very close to the floor," says George Saravelos, foreign exchange strategist at Deutsche Bank in London.

This article first appeared on FX Week.