Then a decline in share prices sparked a massive margin call that Archegos was unable to meet, leading banks to liquidate the family office’s assets.
The result was combined losses of $10 billion for global banks, according to estimates from JPMorgan.
Now in order to prevent similar blow-ups in the future, banks are taking action to reduce risk associated with hedge fund clients. The Securities and Exchange Commission has also opened an investigation into the matter.
Specifically, Nomura is tightening leverage for some clients that were previously granted exceptions to margin financing limits, Bloomberg said, citing people with direct knowledge of the matter.
The Japanese firm is the second bank to take action after the Archegos collapse.
Credit Suisse said earlier in the week that it will change margin requirements on swap agreements to dynamic from static after the collapse. Dynamic margin requirements force clients to post more collateral as positions move down, rather than setting a fixed margin requirement at the onset of the leverage contract.
Before the Archegos implosion, Nomura had been hitting on all cylinders with net income reaching a 19-year high for the nine months ended in December.
Now though, the bank has been forced to cancel the planned issuance of $3.25 billion in senior notes and share prices are down roughly 20% from March 26 highs.
The Archegos Capital Management boss – whose portfolio was swiftly dismantled when his leveraged stock bets soured and he defaulted on his lenders’ margin calls – is the cofounder of the Grace and Mercy Foundation, a Christian charity that helps the poor and oppressed.
Grace and Mercy’s tax filings, reviewed by Insider on ProPublica, show Hwang donated around 121,000 Amazon shares, 945,000 Netflix shares, and 51,000 Facebook shares to the foundation over the past decade. Grace and Mercy sold those shares for about $325 million in total between 2017 and 2018, scoring a handsome $186 million gain.
However, if the foundation had kept the gifts instead of selling them, they would fetch around $946 million today, reflecting the three stocks’ price gains in recent years.
Grace and Mercy also bought shares in Amazon, Netflix, Apple, Expedia, and other companies, its tax filings show. It cashed them in for a total of $200 million between 2014 and 2016, notching a $103 million gain.
Those shares would be worth $722 million today, including Amazon stock worth $449 million and Netflix shares worth $219 million.
Grace and Mercy, which boasted nearly $500 million in assets at the end of 2018, may have cashed in Hwang’s stock gifts because it needed to finance grants to charities and fund its operations. But it undoubtedly left money on the table by selling them.
Hwang is one of several “tiger cubs” who left billionaire investor Julian Robertson’s Tiger Management to start their own funds. He shut down Tiger Asia Management in 2012 after pleading guilty to insider trading in federal court, and launched Archegos in 2013.
Global banks are expected to lose up to $10 billion following the Archegos Capital Management meltdown, JPMorgan said Monday – raising its estimate from an initial $2 billion-$5 billion – with Credit Suisse Group and Nomura Holding hardest hit.
“One line of argument which could explain why the scale of losses suffered by [Credit Suisse] and Nomura was higher could be a higher level of leverage extended by these banks compared to [Goldman Sachs and Morgan Stanley], which seem to have suffered smaller losses if any,” JPMorgan analysts led by Kian Abouhossein said in a research note Monday.
JPMorgan clarified that there may also be additional considerations that determined the sizable difference between the scale of losses suffered, such as the timing of the sale of positions, among others. Nonetheless, the entire episode affects the industry overall, given that global banks could end up losing five times the normal loss level for a collateralized daily mark-to-market business.
JPMorgan cites three lessons the industry could take away from the fund’s implosion.
First, investment banks in general are in better shape today and are more focused on high-volume execution platforms.
“There is no excessive leverage in the [investment banking] or [private banking] industry,” JPMorgan said. “Although [private banking] leverage has been increasing, it is nowhere near prior peaks.”
The bank also said it sees no excessive equity-swap growth, a simple instrument all parties will benefit from.
Second, US regulatory frameworks like Basel III and the Dodd-Frank Act have improved the risk profile of investment banks. JPMorgan, however, noted that there is still weak oversight for non-bank entities, especially when it comes to family offices.
Archegos, a family office founded in 2012, did not have to disclose investments, unlike traditional hedge funds. JPMorgan also pointed to the lack of transparency when it came to equity-swap filings.
The Archegos sell-off exposed the fragility of the financial system, especially those involving lesser-known practices such as total return swaps, a derivative instrument that enabled Bill Hwang’s office not to have ownership of the underlying securities his firm was betting on and the secrecy of family offices. Typically, family offices enjoy the “private adviser exemption” provided under the Advisers Act to firms as these usually advise less than 15 clients, among other conditions.
But JPMorgan said, “filing requirements would have applied to Archegos given its sizable exposure to some US securities. However, the fact that Archegos did not file with the [Securities and Exchange Commission] can be explained by the usage of total return swaps, which seems to be the primary method through which the sizable positions were built by Archegos.”
Dan Berkovitz, a Democratic commissioner on the Commodity Futures Trading Commission, denounced family offices and their ability to skirt some oversight.
“A ‘family office’ has nothing to do with ordinary families,” he said in a statement on April 1. “Rather, it is an investment vehicle used by centimillionaires and billionaires to grow their wealth, reduce their taxes, and plan their estates.”
Third, JPMorgan said private banks, specifically those linked to Archegos, moving forward could improve their onboarding, especially with clients with backgrounds such as Hwang, who has run into trouble in the past. Private banks could also strengthen their risk management by giving less leverage to non-transparent family offices with concentrated positions and ensure checking the clients’ rehypothecation risk, among others.
Archegos in late March used borrowed money to make large bets on some stocks until Wall Street banks forced Archegos to sell over $20 billion worth of its shares after failing to meet a margin call. Hwang grew his family office’s $200 million investment to $10 billion. Reports say the former Tiger Management trader lost $8 billion in 10 days.
But a sharp decline in ViacomCBS sparked a massive margin call that Archegos was unable to meet, leading to a massive liquidation that cost some banks billions of dollars in losses. Credit Suisse seems to have been most exposed to Archegos after not unwinding Hwang’s positions fast enough amid the market tumult last month. The bank said it booked a $4.7 billion write-down related to the event.
Now, to prevent a similar blowup from happening again, Credit Suisse is tightening its financing terms given to hedge funds and family offices, according to a Bloomberg report.
The bank is changing its margin requirement on swap agreements to dynamic from static, which is similar to the terms given in its prime-brokerage contracts, Bloomberg said, citing people with direct knowledge of the matter. A dynamic margin requirement would force its clients to post more collateral as a position moves down, rather than setting a fixed margin requirement at the onset of the contract.
The shift to dynamic margin requirements will increase the costs for hedge funds and family offices looking to use swap agreements, making the trades less profitable. Credit Suisse is now asking some clients to immediately switch to the news margin methodology, according to the report.
Whether Credit Suisse’s move is more indicative of a broader limitation on the leverage hedge funds and family offices can take on remains to be seen.
Bill Hwang built up a fortune of around $20 billion through savvy investments, but then lost it all in 2 days in March as his Archegos investment fund imploded after some of his bets went awry, a report has said.
Hwang, an alumnus of famed hedge fund Tiger Management, took around $200 million in 2013 and turned it into a $20 billion net worth by betting successfully on technology stocks, Bloomberg said in the most detailed look at Archegos’ finances yet.
But it all came crashing down at the end of March when some of Hwang’s highly leveraged bets started to go wrong and his banks sold huge chunks of his investments. The sales knocked around $35 billion off the value of various US media and Chinese tech firms in a day.
Bloomberg reported that Hwang’s early investments through his Archegos Capital Management family office included Amazon, travel-booking company Expedia, LinkedIn and Netflix, the latter of which reaped a $1 billion payday. Bloomberg cited people familiar with Hwang’s investments.
Hwang’s bets at some point shifted towards a broader range of firms, in particular media conglomerates ViacomCBS and Discovery. He also loaded up on Chinese tech companies such as Baidu and GSX Techedu.
Archegos’ investments powered it to a strong final quarter of 2020, with many of the stocks it held jumping more than 30%.
But the ViacomCBS bet would become particularly problematic for Hwang. It started to tumble during the week starting March 22, causing Archegos’ prime brokers – the major banks who lent it money and processed its trades – to demand more money as collateral, known in the business as a margin call.
With Hwang unable to put up the cash, Morgan Stanley sold around $5 billion of Archegos’ holdings at a discount, according to Bloomberg. Goldman then followed suit, selling billions of dollars of companies’ stock.
Some banks weren’t so fast, however, with Credit Suisse and Nomura left nursing estimated losses of $4.7 billion and $2 billion respectively.
A key reason that Hwang’s wealth collapsed so spectacularly is that he used large amounts of leverage. That is, Archegos borrowed lots of money to fund his investments, meaning it faced large losses when they went bad.
Gerard Cassidy, US bank analyst at RBC Capital Markets, told Insider in March: “Leverage is always a two-edged sword. In a bull market when prices are rising it enhances your returns. And then in a falling market, like you just saw in this particular case, it cuts your head off.”
Archegos was unavailable for comment but spokesperson Karen Kessler told Reuters at the end of March: “This is a challenging time for the family office of Archegos Capital Management, our partners and employees.”
“All plans are being discussed as Mr. Hwang and the team determine the best path forward,” she said.
Credit Suisse warned on Tuesday it expects to suffer a $4.6 billion charge to its first-quarter profits following the failure of a US-based hedge fund to meet its margin requirements.
The European lender sees an overall loss of $958 million for the first quarter after two significant crises this year. The Archegos blow-up led to major losses for the bank’s unit that services hedge funds, according to media reports. Prior to that, Credit Suisse terminated $10 billion of supply-chain finance funds linked to troubled financier Lex Greensill.
“The Board of Directors has launched two investigations, to be carried out by external parties, into the supply chain finance funds matter and into the significant US-based hedge fund matter,” the bank said in a statement.
It has now proposed a cut to its dividend and waived bonuses for the 2020 financial year. Further, Chairman Urs Rohner is giving up his “chair fee” of 1.5 million francs ($1.6 million).
Credit Suisse CEO Thomas Gottsein will remain at the bank’s helm. But the lender’s chief risk officer, Lara Warner, is departing on Tuesday. The head of its investment bank, Brian Chin, will leave by the end of April. Joachim Oechslin has been appointed as Warner’s interim replacement, while Christian Meissner will take over Chin’s role.
Insider has learnt that Paul Galietto, head of equities sales and trading, is also stepping down. He will be temporarily replaced by Anthony Abenante, global head of execution services.
Thomas Grotzer, who previously served as general counsel and an executive board member, has been appointed as the bank’s global head of compliance with immediate effect.
Archegos Capital, the highly-leveraged family office of former “Tiger cub” Bill Hwang, triggered a $20 billion forced liquidation of its holdings last month. Archegos had borrowed from a host of banks including Goldman Sachs, Credit Suisse, and Nomura using leverage – or buying stocks on credit.
The fund collapsed after bets it made in stocks such as ViacomCBS, Tencent, and Baidu tumbled below a certain level, leaving its bankers with collateral that wasn’t worth as much. Its lenders, fearing that Archegos could default on its margin obligations at any moment, exited their positions.
“The significant loss in our Prime Services business relating to the failure of a US-based hedge fund is unacceptable,” Gottstein said in a statement. “In combination with the recent issues around the supply chain finance funds, I recognize that these cases have caused significant concern amongst all our stakeholders.”
Leaders at Switzerland-based Credit Suisse are discussing replacing chief risk officer Lara Warner, after the bank was caught up in several high-profile incidents, leading to large potential losses, Bloomberg reported. The outlet cited people briefed on the matter.
Despite chief executive officer Thomas Gottstein’s commitment to a clean slate in 2021, after a previous spying scandal at the bank, Credit Suisse has been one of the worst-performing major bank stocks in 2021.
The recent collapse of Greensill, along with chaos at Archegos, has potentially left investors facing another quarter of losses.
The role of Brian Chin, CEO of Credit Suisse’s investment bank, is also under scrutiny, two of the sources told Bloomberg. They added that the bank is planning a review of its prime brokerage business, which is housed under its investment bank.
Credit Suisse declined to comment.
The bank was one of the main lenders to the Softbank-backed Greensill, a supply-chain lender that was recently forced to file for bankruptcy. A $140 million collateralized loan to Greensill is now in default, although $50 million has been recently repaid by administrators, Bloomberg reported.
This is essentially pooled debt that is taken to market via a single security. Investors receive scheduled payments from the loans but assume most of the risk in the event that borrowers default.
The Swiss bank’s asset management unit also ran a $10 billion group of funds with Greensill, which are being wound down.
On Monday, the Swiss firm had $4.8 billion wiped from its market capitalization on Monday. Its shares tumbled as much as 14% when the bank warned it could suffer a major blow to its first-quarter profits after Archegos, a US-based hedge fund liquidated.
It said the losses could be “highly significant and material” to its first-quarter earnings, due next month.
Archegos, the family office of trader Bill Hwang, was forced to liquidate more than $20 billion of leveraged equity positions last week. The fire sale hammered stocks such as ViacomCBS and Baidu, and set off alarms at multiple Wall Street banks.
The bank could face a loss of $3 billion to $4 billion, the Financial Times reported, citing two sources. The top end of that estimate would be almost triple its net income in the first quarter of 2020. From the Archegos trades, the banking sector could take a collective hit of up to $10 billion, JPMorgan analysts have estimated.
Bloomberg noted that this is only adding to the scrutiny on management, after several other miscues at the investment bank and beyond, including exposure to the Luckin Coffee Inc. fraud.
Gottstein is expected to remain CEO, the people told Bloomberg.
The latest issues for the bank could also put its planned share buyback at risk, potentially pausing it for a second time, Bloomberg reported, as losses could threaten the bank’s dividend distribution.
Credit Suisse declined to comment on the potential fallout of the trades.
The derivatives instruments that triggered the Archegos Capital Management implosion have for years been scrutinized by regulators and some of Wall Street’s biggest investors, including Warren Buffett.
Archegos’ investments were partially concentrated in derivatives called total-return swaps. The highly leveraged trading strategy also had a role in the fallout of Long-Term Capital Management, a hedge fund that failed in 1998 and ultimately required a bailout from a consortium of Wall Street banks to prevent a financial-market collapse.
In the letter, Buffett described how LTCM used total-return swaps and how the instruments are contracts that can facilitate 100% leverage in various markets, including stocks.
In a total-return swap, one party, usually a bank, puts up all the money for the purchase of a stock, and another party, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes, Buffett explained.
“Total-return swaps of this type make a joke of margin requirements. Beyond that, other types of derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions,” the investor said.
He said highly experienced investors and analysts could encounter major problems analyzing the financial conditions of firms that are heavily involved with derivatives contracts, including total-return swaps. He said that when he and Berkshire Vice Chairman Charlie Munger read through the footnotes detailing the derivatives activities of major banks, the only thing they understood was that they didn’t understand how much risk the institution was running.
“The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear,” Buffett said.
He said that the derivatives businesses were expanding “unchecked” and that central banks and governments had found no effective way to control or even monitor the risks posed by these contracts.
Archegos was trading on leverage using total-return swaps, and, according to Forbes, the family office did not disclose its position and subsequent transactions because Securities and Exchange Commission law exempts family offices from disclosing these trades.
Amid the largest melt down of a firm Wall Street has witnessed since the global financial crisis, it wasn’t just banks that lost billions. Bill Hwang, the man behind Arcehgos Capital Management, also suffered a staggering $8 billion dollars in 10 days – one of the fastest losses of that size traders have ever seen, The Wall Street Journal reported.
The massive selloff was largely felt on Friday last week when shares of media conglomerates and investment banks dropped off, sending shockwaves through the market and sparking fears of wider spread contagion.
Japanese firm Nomura Holdings said it could suffer a possible loss of around $2 billion, while Credit Suisse Group, which has declined to provide a numerical impact, could see around $3 billio-$4 billion, according to reports.
Hwang, who founded Archegos as a family office in 2013, used borrowed money to make large bets on some stocks until Wall Street banks forced his firm to sell over $20 billion worth of shares after failing to meet a margin call, hammering stocks including ViacomCBS and Discovery.
The fiasco exposed the fragility of the financial system, especially those involving lesser-known practices such as a total return swaps, a derivative instrument that enabled Hwang’s office not to have ownership of the underlying securities his firm was betting on.
It also revealed the lack of oversight of family offices, which manage more than $2 trillion, The Wall Street Journal reported. Family offices don’t have to disclose investments, unlike traditional hedge funds.
“The collapse of Archegos Capital Management and the billions of dollars in losses to investors and other market participants is a vivid demonstration of the havoc that errant large investment vehicles called ‘family offices’ can wreak on our financial markets,” Dan Berkovitz, a Democratic commissioner on the Commodity Futures Trading Commission, said in a statement, Thursday.
“A ‘family office’ has nothing to do with ordinary families. Rather, it is an investment vehicle used by centimillionaires and billionaires to grow their wealth, reduce their taxes and plan their estates,” Berkovitz said.
The founder grew his family office’s $200 million investment to $10 billion, but he did not need to register as an investment advisor since he was only managing his own wealth.
But this isn’t the first time the devout Christian founder, who is known for his risky investments, has run into trouble. In 2012, Hwang pleaded guilty to insider trading and closed down his Tiger Asia Management fund. He was banned from managing clients’ money in the US for five years. In Hong Kong, he was also banned from trading securities in 2014 for four years.
Yet, in spite of the huge losses as a result of his fund’s implosion, some have praised Hwang’s abilities.
Tom Lee, head of research at Fundstrat Global Advisors, in a tweet on Tuesday, said investors should be cheering hedge fund successes not jeering their failures. Lee said Hwang, who he has known for many years, is “easily in the top 10 of the best investment minds” that he knows.