Margin for error

A fund with assets of about $10bn held positions worth more than $50bn, according to a source who spoke to Reuters.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} That is leverage of five to one, hardly exotic for a bank. It is rather more interesting in a firm that, until last week, almost nobody had heard of.

The firm is Archegos Capital, the New York family office of Bill Hwang, a former Tiger Management trader.^{5Bloomberg, via Taipei TimesMajor banks tally Archegos damage30 Mar 2021} It failed to meet margin calls from its lenders, and what followed was a fire sale. Forced liquidations of more than $20bn of Archegos-linked positions rattled stocks from Baidu to ViacomCBS.^{5Bloomberg, via Taipei TimesMajor banks tally Archegos damage30 Mar 2021} On Friday 26 March, Morgan Stanley, one of Archegos’s prime brokers, was among the banks managing block trades that wiped out $35bn from the value of bellwether stocks, according to people familiar with the matter.^{5Bloomberg, via Taipei TimesMajor banks tally Archegos damage30 Mar 2021} Shares in ViacomCBS and Discovery each fell about 27% that day.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} On Monday Nomura said it faced a possible loss of about $2bn from transactions with a US client, and cancelled a $3.25bn bond issue.^{1Nomura Holdings (SEC filing)Possible Loss Arising from Business Activities (Form 6-K)29 Mar 2021,3Reuters, via Investing.comNomura flags $2 billion loss, cancels bond issue; shares plummet29 Mar 2021} Credit Suisse said a US-based hedge fund had failed to meet margin calls and that its loss could be “highly significant”.^{2AP, via Advisor.caGlobal banks warn of possible losses from hedge fund default29 Mar 2021} Nomura’s shares fell by as much as 16%.^{3Reuters, via Investing.comNomura flags $2 billion loss, cancels bond issue; shares plummet29 Mar 2021}

Five times the assets. Archegos Capital, approximate, $bn

	Archegos
Assets	10
Positions	50

Source: Reuters, citing a source⁴

We think the lesson is not that Mr Hwang bet too heavily on a few media stocks. Investors are allowed to be wrong. Mr Hwang has also met the regulator before: he and his earlier firm paid $44m in 2012 to settle charges of insider trading brought by the Securities and Exchange Commission.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} The lesson is that nobody outside a handful of banks could see the position being built. Rules written for a world of shares and funds have been overtaken by the instruments that sit between them, and they should be rewritten.

Start with how Archegos reportedly held its bets. It bought total return swaps, derivatives that let an investor profit from a stock’s moves without owning it; the fund posts collateral rather than paying cash for the shares.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} The shares themselves sat with the prime brokers that lent to Archegos and processed its trades.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} Economically the position was Mr Hwang’s. Legally, the banks owned it. A disclosure regime that turns on who holds a stock had little to record.

Then there is the family office. Such vehicles act as private wealth managers and face lower disclosure requirements than other investment companies, as Reuters put it.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} Mr Hwang converted his hedge fund into one.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} The logic is respectable: a billionaire investing his own money does not need a regulator to protect him from himself. But Archegos was not a hobby. At five times its assets, its fortunes were tied to those of its lenders, and, as Friday showed, to those of every holder of the shares it was forced to dump.

The strongest defence of the status quo is that the system worked. The banks, not taxpayers, are bearing the loss. Nomura says its common equity tier 1 ratio was over 17% at the end of December and that there will be “no issues related to the operations or financial soundness” of the group.^{1Nomura Holdings (SEC filing)Possible Loss Arising from Business Activities (Form 6-K)29 Mar 2021} Goldman Sachs, a person familiar with the matter told Bloomberg, found its loans fully collateralised and has exited most of its Archegos-related positions.^{5Bloomberg, via Taipei TimesMajor banks tally Archegos damage30 Mar 2021} Losing money is how markets teach risk managers lessons.

That is too comfortable. Banks that lose money are a private matter; banks that lose money at the same moment, selling the same shares to each other’s clients, are a public one. Each prime broker had every reason to exit first, and some evidently did. Those left holding the last block, such as Nomura and Credit Suisse, found out what a queue is. Reuters reports that global banks may lose more than $6bn in total, with Credit Suisse likely to lose at least $1bn.^{4Reuters, via Malay MailGlobal bank losses may top US$6b on Archegos downfall30 Mar 2021} Nobody in the queue could see the others, because nobody was required to.

So what should change? Regulators in America and Europe should require swap positions in listed shares to be reported alongside physical holdings once they cross the thresholds that already apply to shares, with banks, who can see the trades, responsible for the reporting. Family offices that borrow heavily against listed securities should be treated as the funds they resemble and made to report their leverage to a supervisor, in confidence if need be. And supervisors should ask the biggest prime brokers, as a matter of routine, how much of one client’s portfolio sits in a handful of names, and how many of their rivals lend to the same client.

None of this would have stopped Mr Hwang from being wrong. It might have spared the banks from learning, together and on a Friday, that they had all lent to the same man.