Regulators need to look at leverage in the prime brokerage business at the center of the Archegos meltdown, Guggenheim’s Millstein says

Jim Millstein
  • Jim Millstein of Guggenheim Securities said regulators should look into the prime brokerage business.
  • The co-chairman noted that lenders face increased risk when hedge funds use excessive leverage.
  • Millstein doesn’t believe the Archegos collapse presents a “risk to the financial system,” however.
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Guggenheim’s co-chairman Jim Millstein believes regulators should keep an eye on leverage in the prime brokerage business at the center of the Archegos meltdown.

In an interview with Bloomberg on Tuesday, Millstein said that the Financial Stability Oversight Council, which was formed under the Dodd-Frank Act of 2010, should “take another look at the prime brokerage business and the kinds of leverage that’s being extended both through the derivatives markets and directly.”

The prime brokerage business is a bundled package of services offered by investment banks, wealth management firms, and securities dealers to hedge funds that allows them to borrow securities and cash.

Millstein discussed how “regulation T,” a collection of provisions that govern margin requirements for retail investors, doesn’t apply to family offices and hedge funds.

“Clearly family offices, hedge funds, other institutional investors clients of the prime brokerage business have been able to obtain much more significant leverage than the average investor, and so, and obviously there are risks associated with it,” Millstein said.

The co-chairman added that “when you’re highly levered against individual names and not terribly diversified you do run a significant risk of an effective margin call.”

Millstein said that this type of leverage not only puts hedge funds at risk, but lenders as well. If lenders are unable to liquidate collateral positions or cover derivate exposures fast enough there can be significant losses.

What Millstein is describing is exactly what happened to Credit Suisse, among others, after the recent Archegos collapse.

Credit Suisse said it will have to absorb a $4.7 billion write down due to its Archegos exposure. For reference, the investment bank’s total net income for 2020 was roughly $2.9 billion.

The firm has faced significant fallout after its Archegos losses with numerous top execs stepping down including the head of investment banking Brian Chin and the chief risk and compliance officer Lara Warner, as well as Paul Galietto, the head of equities sales and trading.

Millstein also agreed with his colleague Scott Minerd who said that another Archegos-like implosion is “highly likely” moving forward.

When asked if the Archegos blow-up might lead to reverberations for the markets as a whole, Millstein pointed out that there is still “an enormous amount of monetary and fiscal stimulus” in the system and more could be on its way with President Biden’s Infrastructure bill.

The co-chairman said he doesn’t believe the Archegos collapse represents a “risk to financial stability” based on the relative size of the hedge fund and current market conditions.

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CME Group, world’s largest derivatives marketplace, to offer micro bitcoin futures in May

Bitcoin
Bitcoin.

CME Group, the world’s largest derivatives marketplace, announced that it is expanding its suite of crypto offerings with micro bitcoin futures as the popular coin gains traction from both institutional to retail investors, propelling it to record highs.

The micro bitcoin futures of CME, or Chicago Mercantile Exchange, will be one-tenth the size of one bitcoin and will start trading on May 3, pending regulatory review.

The smaller-sized contract, which can be settled on a cash basis, will allow investors to trade bitcoin in an efficient and cost-effective way on fractional units. Other cryptocurrency exchanges that are less regulated already offer bitcoin futures.

“The introduction of micro bitcoin futures … will offer even more choice and precision in how participants can trade regulated bitcoin futures in a transparent and efficient manner at CME Group,” Tim McCourt, CME Group global head of equity index and alternative investment products, said in a statement.

CME Group launched a bitcoin futures contract in 2017 and has seen steady market participation among institutional traders. Micro bitcoin futures will join CME Group’s other offerings, including the recently launched ether futures.

“This will serve as a great function,” John Wu, president at AVA Labs, told Insider. ” It will increase participation, subsequently increasing liquidity, and, will provide hedging opportunities.”

Micro bitcoin futures will be listed on and subject to the rules of CME.

This far, CME said it has seen 13,800 bitcoin futures contracts (equivalent to around 69,000 bitcoin) and 767 ether futures contracts traded (equivalent to 38,400 ether) on average per day.

CME rival Chicago Board Options Exchange was the first to introduce the derivatives contract in 2017 but has since stopped trading bitcoin futures.

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No one should be surprised at the Archegos blowup, given the ‘wild west’ nature of the swaps market, Heritage Capital’s Paul Schatz says

Trading floor
Inside a trading floor on the New York Stock Exchange

  • “Epic greed and euphoria” have led people to make mistakes and go “beyond irresponsible behaviour,” Paul Schatz said in an interview.
  • The swaps market needs to be regulated and funds must disclose more, the head of Heritage Capital said.
  • Cases like this and January’s GameStop saga paint a negative picture of money managers, he continued.
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The implosion of Archegos Capital over its derivative holdings that went sour should not come as a surprise to anyone, given the opaque and volatile nature of the swaps market in which the US hedge fund invested, Paul Schatz, president and founder of Heritage Capital, said on Monday.

Archegos Capital was forced to dissolve its holdings at the end of last week as it had become unable to meet margin calls from its lenders, sending major entertainment and tech stocks tumbling. The family office was facing financial difficulties even before then and various big banks had to tried to prevent a crisis by entering into swaps contracts with Archegos last week. This exposed its funds to volatile equities worth billions of dollars.

On Monday, Credit Suisse and Nomura announced that they would suffer significant losses after a US hedge fund was forced to liquidate its stock holdings when it could not meet margin calls from its lenders. Their share prices dropped significantly on Monday along with those of other major banks and the companies Archegos – which a number of media outlets confirmed was the fund in question – had previously held.

“The swaps market is, frankly, like the wild west,” Schatz told Yahoo Finance in an interview.

Years of super-cheap financing thanks to low interest rates set by central banks has fueled a record boom in investment, sending stocks to record highs and inflating the value of everything from cryptocurrencies, to junk bonds.

Schatz said this had led to “epic greed and euphoria” in the sector over the last six months. Paired with high levels of confidence and the hubris of investors, this inevitably leads to people making “egregious mistakes” and engaging in “beyond irresponsible behaviour” he continued, drawing lines between the current situation and cases like the 1998 Long Term Capital Management crisis, in which one of the world’s biggest hedge funds blew up, roiling markets and requiring government intervention.

Fund managers that own assets beyond a certain size must report their positions regularly to the US regulator. However, this does not apply to the type of swaps that Bill Hwang’s Archegos Capital used. Schatz said these were “essentially non-disclosed, undisclosed, secret derivatives”.

Schatz pointed out markets were already jolted once this year in January, when retail traders organized themselves through Reddit and bought up shares in GameStop, which resulted in skyrocketing prices and forced some institutional investors who had bet against the video retailer to close those positions, even at a loss.

Schatz predicts the public will continue to lose confidence in the stability of financial markets and regulators and politicians will get involved. “These large funds that have very little disclosure requirements like this certainly need to have more disclosure in the swaps market,” he said.

He said the problem with using swaps – a form of derivative – was positions being leveraged over and over again, without prime brokers being aware of what their competitors are doing – this “can become this ginormous pile of leverage that only takes the slightest little prick” to unravel.

“The swaps market should not exist the way it is. It fully should be brought on exchange, there should be better disclosure and there should be better protection for investors” Schatz said.

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Binance, the world’s largest crypto exchange, probed by CFTC over concerns it allowed US residents to trade derivatives

Changpeng Zhao
Binance CEO Changpeng Zhao


Cryptocurrency exchange Binance Holdings is being investigated by the Commodity Futures Trading Commission (CFTC) over concerns that it permitted US residents to trade derivatives, violating the agency’s regulations, Bloomberg first reported on Friday.

Binance, the world’s largest crypto exchange, is not registered with the CTFC to trade those types of securities. The agency counts cryptocurrencies such as bitcoin to be commodities and therefore oversees its futures and other derivatives.

The CTFC has yet to determine whether the cryptocurrency exchange did allow US residents to buy and sell derivatives. Thus far, Binance has not been accused of misconduct.

Binance, which was founded in China and has an office in Singapore, says it currently does not have a headquarters. For now, US residents are unable to access its website.

“We have always blocked US access, but users do find intelligent ways to get around our block sometimes and we just have to be smarter about the way we block,” company co-founder Changpeng Zhao told Bloomberg in November.

Zhao has, in the past, maintained that Binance complies with US laws. In 2019, Binance partnered with BAM Trading Services, which launched Binance.us in San Francisco. Binance licenses its matching engine and wallet technologies to Binance.us.

Still, many users find a workaround, especially amid the boom in bitcoin which has flirted with record highs on Thursday, breaching the $1 trillion market capitalization threshold. The founder told Bloomberg in a February television interview that his platform is attracting more than 300,000 user registrations a day, far surpassing its previous 2017 peak.

The heightened scrutiny against Binance and other crypto-related firms comes after lawmakers and watchdogs have raised their concerns about the rapidly evolving asset.

US Treasury Secretary Janet Yellen has publicly criticized bitcoin numerous times as well as ECB president Christine Lagarde.

In November last year, CFTC filed criminal charges accusing founders and executives of the BitMEX, a major cryptocurrency derivatives exchange of not taking sufficient steps to prevent money laundering.

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