FX traders tell us why they're still talking about Nigel Farage and the 'crackpot lunatic conspiracy theory' of a massive short against the pound on the night of the Brexit vote
- Nigel Farage made predictions on the night of the Brexit vote that turned out to be wrong, even though he knew of two private polls that predicted the correct outcome.
- Sources in the FX trading world told Business Insider of a speculative theory that someone placed a massive "knock-in short" against the pound.
- Such a bet would require the pound to move up on June 23 before it fell, which is exactly what the pound did after Farage spoke.
- FX traders say pricing data on the night shows the "knock-in short" theory is plausible.
- Farage told Business Insider that this is "a crackpot lunatic conspiracy theory."
LONDON - As the EU Referendum approached in 2016, foreign currency traders knew they were looking at a "multi big fig" day. The beauty of June 23 from a trader's perspective was that whichever way the vote went, it would move the pound against the dollar dramatically - "multiple big figures" - and not the mere decimal places that characterize most currency movements. If Britain voted to remain in the EU, the pound would bounce sharply up against the dollar. If the UK voted to leave Europe, the pound was expected to fall quickly.
The Brexit vote was going to be close. Polls suggested a 52% vs 48% victory for Remain, but that was near the margin of error. Major polling organisations had declined to conduct exit polls on the day because the vote was so unusual they had no comparative data to ensure their accuracy. The result was going to be tight and uncertain.
Leave won and the pound went into freefall on the night. The EU Referendum was the most dramatic day in sterling trade since "Black Wednesday" in 1992, when George Soros placed a short bet against the pound and forced the Bank of England to abandon the European Exchange Rate Mechanism.
For FX traders, that type of big, sudden movement is a golden opportunity. You can make a lot of money if you know which direction the pound is going before it moves.
Unsurprisingly, traders have gossiped since that day about who made money and who lost. The gossip was fueled recently by a Bloomberg report that said several hedge funds bought in-depth private polls showing that Leave was the likely winner even though less-robust polls for the media were tipping Remain.
The report also says that Nigel Farage, the leader of the United Kingdom Independence Party, made predictions on the night of the vote that turned out to be wrong, even though he had been supplied with information from two private polls that predicted the correct outcome.
A source who has been in the FX trading world for years told Business Insider that his favourite speculative theory about Farage's statements was that someone used them to place a massive "knock-in short" option strategy on the pound. Such a bet would require the pound hit a specific price before falling - something that a lack of liquidity in the market indicated was unlikely to happen on the night.
And yet the pound did exactly that.
If the theory is true, they made a lot of money.
"A crackpot lunatic conspiracy theory"
We can't say what exactly happened. Farage denied to Business Insider that he knew anything about short action on the pound on June 23, 2016. And there is no suggestion that Farage has engaged in any wrongdoing. But FX traders in The City are gossiping. Below is our explanation of the Brexit "knock-in short" theory, as told to us by one trader.
Farage told Business Insider that the theory is "a crackpot lunatic conspiracy theory." He points out that most polling companies, including YouGov - which had embedded itself in a hedge fund's office on the evening of the vote - got their pro-Remain predictions wrong, just like he did. He believed their data, he says.
Ken Veksler, the director of Accumen Management, who has traded currency for 22 years, told Business Insider that he thinks the "knock-in short" theory is plausible: "Is it possible? Most certainly yes. Is it probable? In the absence of knowing for certain, I'm inclined to say ... maybe?!"
Another trader, FX strategist Viraj Patel of ING, told Business Insider that "you can make the position that there was a knock-in short." Of course, like everyone else, he says it cannot be proven either way.
And Jordan Rochester, G10 FX strategist at Nomura, said via email, "Knock-in shorts could definitely have been triggered, (i.e. a put spread with a knock in at a higher strike than current spot that expires worthless if not triggered = makes it very cheap but potentially very valuable given what happened on Brexit). But I have to say it would have been a heroic assumption in advance to have bought a GBPUSD put with a knock-in at 1.50." It would have been easier to simply short the pound on the day, he said, and thus the theory seems improbable.
Regardless, this is what traders have been talking about in the month since the Bloomberg story was published.
"I think Remain will edge it"
The controversy exists because one of the private hedge-fund polls was done by Survation, a polling company so close to Farage's UKIP that the two organisations once shared an office, according to Bloomberg.
As the referendum voting came to an end, Farage was told that Survation was predicting a Remain victory, Farage confirmed to Business Insider. Separately, UKIP-funder Arron Banks had also commissioned a private poll, according to the Financial Times. And both polls were showing that Leave had won.
On that basis, the pound should have been going down.
Yet Farage gave two statements to the media that night, saying "I think Remain will edge it."
Unsurprisingly, once the statements were aired by Sky News and the Press Association after the polls closed at 10 p.m., the pound moved up against the dollar, from around $1.48 where it had been at 8 p.m. to over $1.50 - a significant move for a major currency. Investors, believing Britain would stay inside the EU, were showing their confidence in the British economy by buying up the pound against the dollar.
They were heading the wrong way.
Farage told Business Insider that he had given his statements to the press at 8 p.m. that evening, and they were only aired by the media at 10 p.m., after the polls closed. He disregarded the Survation and Banks data because "I didn't believe it. I did not believe Banks was right," he told us. All the other polls showed a Remain win. Farage says he did not become convinced that Leave had won until after several constituencies reported their actual votes, by 2 or 2.30 a.m. that night.
Significantly, anyone who knew between 8 p.m. and 10 p.m. that Farage was going to say that Remain won even though his polling data said the opposite might have some actionable trading data. Two hours is an eternity in the FX markets.
If the Banks and Survation data were reliable, then the pound was likely to fall. So why did it continue to go up?
The "knock-in" option theory argues that if the Banks and Survation data were reliable, and Leave was the likely winner, then the pound was likely to fall. So why did it continue to go up?
The answer is, in part, Farage's statement. Sky News broadcast a statement from him shortly before 10 p.m. that "It looks like Remain will edge it." You can see Farage's "concession" statement on Sky News here, timestamped at 10 p.m. London/11 p.m. Gibraltar, the first constituency to report a result.
Shortly after that, the Press Association published a statement from Farage that said, "I think Remain will edge it, yes." At least one of those statements was made after Farage had been told by Survation and Banks' pollsters that Leave appeared to have won, Bloomberg reported. (Survation denied supplying the information to Farage when asked about it by the Financial Times.)
However, Farage told Business Insider this week that he did know about both polls, but he thought they were both likely wrong. And Farage's PR rep, Gawain Towler, wrote a column for The Telegraph in which he said he knew that Survation had polling data with more depth than the others before the voting was over.
"I knew someone had commissioned Damian Lyons-Lowe and his firm Survation. I also knew that the poll was a big one, far bigger than either Ukip or Leave.EU had previously commissioned, but of course the details of the poll could not be released, as public polling while votes are being cast is illegal," Towler wrote.
At the time the polls closed, the pound had settled at $1.48 while everyone waited for the actual results. There was little liquidity in the spot market, our source says, meaning that traders had locked in their derivative trades, hedged their positions, and no one was trading while they waited for the results to hit the market. "Liquidity was dire," the source says. ING's Patel added that "The only market open was the US. There was really thin liquidity."
The lack of liquidity was matched by a lack of exit poll data
Historically, official exit polls - announced by the media when voting stops at 10 p.m. - have moved the currency markets. "Anyone would be aware that the exit poll itself would drive the currency markets," ING's Patel told Business Insider.
But in 2016, the BBC, ITV and Sky News chose not to commission an exit poll because referendums are so rare in Britain they had no comparable historic data to ensure the results were reliable. "Polls mattered materially" during the Brexit campaign, Patel said. "Especially on the day itself and the days before. Even comments from politicians were driving the pound."
Into that vacuum fell Farage's "concession." Sky led its post-10 p.m. results coverage with Farage's statement, not a prediction of the results. The statement functioned as a concrete piece of public data from a leading politician that indicated a result. In effect, it carried the equivalent weight of an exit poll.
And only after Farage's "concession" did the pound go above $1.50.
In a "knock-in short," an investor makes a short bet but the position isn't "knocked-in" until the pound hits a certain price. Within minutes of Farage's statement being broadcast, the pound moved upward from $1.48.80. Buyers in the spot market plunged into the pound, driving up the price.
As it neared $1.50, the price declined a bit. That is noteworthy because it is a possible sign of sellers "defending" their position in the hopes of keeping it under $1.50. In a "knock-in" short, the counterparty risks losing money if the price target is triggered. So counterparty investors had an incentive to sell pounds in hopes of keeping it below the $1.50 trigger, the theory says. The pound's brief decline after it rose from $1.48 but before it hit $1.50 therefore looks like circumstantial evidence that someone was trying to prevent the pound from reaching $1.50.
But the pound broke upward again, cresting at nearly $150.02.
With the knock-in triggered, the sellers ended their defence and the pound went into an immediate freefall down to $1.30 in early August &mdash a historically swift and brutal collapse. (There is a detailed account of the pound's progress on the night at PoundSterlingLive.com.)
"You have to have balls the size of asteroids to put it on"
In this case, our source speculates that the knock-in trigger was $1.50 and the short position was initiated at $1.55, meaning the investor would gain the difference between $1.55 and anything below that, minus the cost of the trade when the trade was closed out. Crucially, the bet wouldn't pay off if the pound fell from $1.48. It had to go above $1.50 first. In percentage terms, the pound's decline was 13% into August. But FX trades are leveraged or done on margin, so anyone who held a short position earned many multiples of that. Our source believes the cumulative value of the trade was probably somewhere like $500 million.
"You have to have balls the size of asteroids to put it on," our source says.
Our source admits there is no evidence that Farage's statements were coordinated with a knock-in trade. The reason people are still talking about it is that "it looks too clean to be coincidental," he says. Another aspect fuelling the gossip was the lack of liquidity. "The less liquidity you have the less it takes to push the market around," the source says, magnifying the effect of Farage's statements. "You literally need to know nothing other than what a correctly uttered phrase would do to the market."
Patel agrees: "Even the smallest of players could drive the price" because liquidity was so low.
Farage laughed out loud when Business Insider discussed the theory with him. "I think the Russians might have done it! ... I personally made $200 million!" he said. "You're all off your heads!"
If you have any information on who shorted the pound - and why - on the night of the Brexit vote please email jedwards@businessinsider.com. Correspondence will be treated in confidence.