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.
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.
Morgan Stanley sold about $5 billion in shares of now-collapsed hedge fund Archegos Capital Management the night before a massive securities sale took place, CNBC reported Tuesday, citing unnamed sources familiar with the matter.
Archegos’ biggest prime broker sold shares in US media and Chinese tech names to a small group of hedge funds late Thursday, March 25, the report said, adding that Morgan Stanley sold the shares at a discount and told the hedge funds that they were part of a margin call that could prevent the collapse of an unnamed client.
According to the report, sources said the investment bank didn’t tell the buyers that the basket of shares would be the start of an unprecedented wave of tens of billions of dollars in securities sales by Morgan Stanley and five other investment banks starting the next day, on Friday.
The sources told CNBC that Morgan Stanley had Archegos’ consent to shop around its stock late March 25.
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.
Goldman Sachs was quicker than its rivals at offloading billions of dollars of stock held by the imploding investment fund Archegos. Japanese banking giant Nomura wasn’t so fast, according to reports, and is facing losses of around $2 billion in one of its arms.
Now, Goldman analysts have downgraded Nomura’s shares, pronouncing on Tuesday: “We now think upside for the stock looks limited.”
The analysts, led by Shinichiro Nakamura, also lowered their earnings forecasts for Nomura, saying: “We assume the company would look to adopt a generally more risk-focused or cautious approach.”
The major banks that lent to Archegos Capital Management tried to reach an agreement last week when it became clear that Bill Hwang’s fund was struggling to come up with cash to cover its bets, according to reports in the Financial Times and Bloomberg.
Yet those talks broke down, the reports said, and Goldman started selling huge blocks of Archegos’ holdings in companies such as ViacomCBS on Friday, causing stock prices to tumble.
Michael Brown, senior market analyst at Caxton FX, said it was a case of “every bank for themselves.” He added: “Unsurprisingly, [any agreement] quickly fell apart, such is the cut-throat nature of the business.”
On Monday, it became clear Nomura had not been fast enough when it said it was facing “a significant loss arising from transactions with a US client.”
Goldman, itself the heart of the action, swiftly downgraded Nomura’s stock from “buy” to “neutral” on Tuesday.
“We lower our [earnings] estimates given Nomura’s March 29 disclosure that it could book losses/provisions [of] approximately $2 billion,” the analyst said.
Nomura Holdings was down around 19% for the week on Wednesday at 581 Japanese yen, roughly $5.25. Goldman’s new 12-month target price is 630 yen.
Goldman said that if losses in the bank’s prime brokerage business rise to $3-$4 billion, “we would see a possibility that the company could rein in shareholder distributions.”
Nomura and Goldman Sachs both declined to comment.
JPMorgan now reckons the losses at certain banks involved with Archegos, such as Nomura and Credit Suisse, could be as high as $10 billion.
A person with knowledge of the situation said Goldman had “proactively managed” its risk and that its losses were “immaterial.”
Brown said: “For now, it’s a point to GS in this one.”
Tencent Music Entertainment’s board approved a $1 billion buyback program of its class A shares over the next 12 months on Sunday.
Vipshop followed suit this week authorizing a $500 million share buyback program over the next 24 months on Tuesday. Both companies plan on using their existing cash balances for the repurchases.
Larry Xiangdong Chen, the founder, chairman and CEO of GSX Techedu, said he would use personal funds to buy back $50 million worth of his education technology company over the next 12 months in a Tuesday press release as well.
Archegos’ had placed leveraged bets on the Chinese tech firms, among others. When it was forced to rapidly liquidate its positions to pay back banks, shares of its holdings plummeted.
In the past week alone, as of Monday’s closing price, Vipshop fell over 37% while Tencent Music Entertainment and GSX Techedu fell 36% and 56%, respectively.
The Archegos blow-up didn’t just hurt the hedge fund’s holdings either. Banks like Credit Suisse and Nomura have said they are facing significant losses stemming from the event.
Archegos’ was run by Bill Hwang, a former protégé of the hedge-fund titan Julian Robertson, who founded Tiger Capital Management.
Hwang used “total return swaps” to borrow huge sums from banks in relative anonymity without having to put down as much collateral. “Total return swaps” allow users to take on the profits and losses of a portfolio in exchange for a fee.
The tactic has been widely criticized by economists and investors including Warren Buffett. The “oracle of Omaha” said in a 2002 letter to investors that these types of “derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
Retail traders on Reddit’s Wall Street Bets forum took a lot of heat during the recent GameStop saga for coordinating on the forum to pump the price of their favorite stocks.
After the hedge fund Archegos’ historic blowup at the end of last week on the back of leveraged stock bets, many on the platform are pointing fingers back at Wall Street.
In January, traders on Wall Street Bets began targeting stocks with high short-interest rates in hopes of driving a short squeeze and netting quick profits. The beleaguered video-game retailer GameStop became the group’s favorite target.
After GameStop’s share price soared, US regulators eyed whether the Reddit forum and its retail-trading members were part of market manipulation. The Securities and Exchange Commission and the Commodity Futures Trading Commission began reviewing traders’ actions on forums like Reddit to see whether illicit activity took place.
In an interview with CNBC on February 1, Democratic Rep. Stephen Lynch of Massachusetts even argued that Reddit-fueled trading could lead to “systemic risk” in the markets.
Now that the leveraged bets of Archegos have sent a handful of stocks crashing and caused reverberations throughout the markets, Reddit traders are questioning the way they were treated by regulators and the media compared with hedge funds.
A post that garnered over 14,000 upvotes in under five hours on Monday made the Redditors’ case: “Can we just appreciate for a moment that a large multi family private office leveraged themselves to the t–s, defaulted on a margin call, and it causing a market wide sell off to the tune of tens of billions of dollars, and yet I’m the irresponsible retail idiot who’s risky trading is dangerous.”
Archegos Capital is run by Bill Hwang, a former investor at the famous fund Tiger Management. Archegos’ inability to meet margin calls forced banks into block sales of $20 billion of stock held by the firm.
Many Redditors and market commentators questioned why the banks would allow Archegos to leverage its bets to such an extent given Hwang’s history: He pleaded guilty to wire fraud in 2012 after his firm, Tiger Asia, traded on nonpublic information, reaping $16 million of illicit profits in 2008 and 2009, Bloomberg reported.
Bloomberg’s report said that Goldman Sachs had Hwang on its blacklist after he was charged, but “at some point in the past two-and-a-half years, the firm changed its mind about Hwang.”
That change of heart may have allowed Hwang to leverage his bets on equities. While it’s hard to say that the Archegos turmoil has created a systemic risk to the markets, it very well could moving forward.
“The Archegos drama involves a classic mix of massive leverage, concentrated positions, derivative overlays, forced deleveraging, and distressed sales,” Mohamed El-Erian, the president of Queen’s College and the chief economic advisor at Allianz, said in a LinkedIn post. “The pain has been felt so far only in a handful of stocks … What happens next depends on remaining sales and related contagion channels.”
Global stocks rose on Tuesday, as investors shrugged off worries about wider fallout from the $35 billion Archegos default to focus instead on the worldwide progress of the COVID-19 vaccination program.
Futures on the Dow Jones rose 0.2% and the S&P 500 was about flat, suggesting a mixed open for US indices later in the day, while futures on the Nasdaq 100 fell 0.5%, pointing to a lower start for the technology sector. The Dow Jones hit an all-time high on Monday, but the tech-heavy Nasdaq saw a bigger pullback.
A spokesperson for Archegos, the family office of “Tiger cub” Bill Hwang, told Bloomberg in an email “all plans are being discussed” to determine the best path forward. Shares in banks linked to the risky trades didn’t see as much of a decline as Monday, when the financial sector was among the worst performing sectors of the European stock market.
US regulators have called in the banks involved for a “fireside chat,” according to Jeffrey Halley, a senior market analyst at OANDA.
Meanwhile, ViacomCBS fell a further 6.6%, losing more than half its value since a week ago, and Discovery fell another 1.6%.
“Just because markets appear to have moved on this morning, doesn’t mean the dust has settled on Archego Capital’s collapse,” Connor Campbell, a financial analyst at SpreadEx, said. “That situation could still have some nasty surprises up its sleeve.”
Separately in the US, President Joe Biden is expected to deliver a speech on infrastructure spending on Wednesday. The plan could cost as much $4 trillion in new outgoings and include $3.5 trillion in tax hikes, according to the Washington Post. The administration is not expected to expand the child tax credit permanent. Investors are also anticipating the next non-farm payrolls scheduled to release on Friday.
The 10-year US Treasury yield continued its march higher, rising 5 basis points to 1.77%, its highest since the start of the pandemic just over a year ago.
While Europe is at the forefront of a potential new wave of coronavirus infections, the US Center for Disease Control and Prevention has also warned the country risks facing a fresh wave of cases.
In the UK, Prime Minister Boris Johnson said he was hopeful no more lockdowns would be required as the country took its first significant step of easing out of restrictions on Monday.
The Ever Given ship in the Suez Canal was finally freed by a huge dredging vessel after being stuck for nearly a week, allowing normal traffic to resume. But the canal authority says it could take multiple days to clear out the backlog of ships that had built during the blockage. Oil prices were mostly tepid, with Brent crude falling slightly by 0.2% to $61.45 and West Texas Intermediate falling 0.1% to $64.87.