Archegos Ripples Through Banks’ Lucrative Hedge Fund Units

US regulators are considering tougher disclosure requirements for investment firms in response to this year’s implosion of Archegos Capital Management. Securities and Exchange Commission (SEC) officials are exploring how to increase transparency for the types of derivative bets that sank Archegos, the family office of billionaire trader Bill Hwang. SEC signaled the banks to make trading disclosure from Hedge fund as top priority. And by this it will re-assess the relations between them.
While Morgan Stanley and Goldman Sachs acted fast, Nomura and Credit Suisse weren’t so quick. Nomura Holdings and Credit Suisse Group, the two lenders hit hardest, have started to curb financing in the business with hedge funds and family offices. European regulators are looking at risks banks are taking when lending to such clients, while in the US, authorities started a preliminary probe into the debacle.
The prime brokers lends the money and execute their trade and it can be harmful for them even though they have securities as a collateral as seen in the Archegos. Credit Suisse has been the worst-hit so far, taking a $4.7 billion writedown in the first quarter.
The lender, one of the biggest prime brokers among European banks, is now cutting the arms to lends such heavy leverage without optimizing risk in next months. It has already been calling clients to change margin requirements in swap agreements — the derivatives Hwang used for his bets — so they match the more restrictive terms of other prime-brokerage contracts. Specifically, the bank is shifting from static margining to dynamic margining, which may force clients to post more collateral and could reduce the profitability of some trades. Credit Suisse has been forced to take a number of measures. After dumping a significant amount of stock at a loss, the executive board has suspended bonuses related to fiscal 2020. The bank had been under pressure already. Just one month ago, it suffered losses from the collapse of Greensill Capital, a British supply chain finance firm
Nomura, which is facing an estimated $2 billion from the Archegos, followed suit, with restrictions including tightening leverage for some clients who were previously granted exceptions to margin financing limits. This restriction of margin limits can lead to scaling back of the business. Hwang’s family office built positions in at least nine stocks taking more and more leverage on these stocks only through various banks at a time. And the banks couldn’t see they were piling leverage from other banks too. His portfolio was estimate around $100 billion.
While the checks by the European Central Bank on lenders such as Deutsche Bank AG and BNP Paribas SA are standard practice after such a disruptive event, they underscore regulators’ concern, even as most euro-region banks skirted big losses.
Investors can learn a lesson from all this about the high risks of trading on margin. While using margin can make good times for your stocks great for your portfolio, in bad times it is more of losses than you might have gained. And in decline stage margin calls like the ones that crushed Archegos can bring your entire portfolio down.
Heavy use of margin and leverage is one way to turn $20 billion into $200 billion in years — and to turn $20 billion into $0 in just a few days.