Archegos is a Greek word that means one who leads the way. Archegos Capital Management is a family office run by Bill Hwang that invests in stocks in markets like the US, China, Korea, and Japan. Hwang who was formerly working for Tiger Asia Management created the Archegos family office in 2013. It had $200 million at the time when it was founded; compared to $10 billion under management in 2020.
Tiger Asia has previously pleaded guilty to insider trading of Chinese bank stock. Hwang and his firm in 2012 paid $44 million to settle Securities and Exchange Commission trading charges.
On 26 March 2021, Archegos defaulted on margin calls from several global investment banks including Credit Suisse and Nomura Holdings. It liquidated its stake in billions of dollars worth of various stocks which was the main cause for a 27% plunge in the share price of ViacomCBS.
On Friday last week, the selling pressure in select US media stocks and Chinese Internet ADRs was due to the forced liquidation of positions by Archegos Capital. ViacomCBS and Discovery closed down more than 27% with Viacom down more than 50% for the week and Discovery down by 45%. For the week Baidu was down more than 18%, Tencent 33%, and Vishop more than 31%.
This Forced liquidation of stocks was one of the biggest hedge-fund debacles since Long Term Capital Management in 1998.
Credit Suisse and Nomura on Monday said that they could take big hits from their exposure to the hedge fund. This has led traders and investors wondering as to what would happen next. Investors are looking with some concern at the prospect of further large sales hitting financial markets. Some analysts expected the selling to blow over but others were worried that it could have a much wider impact.
Morgan Stanley and Goldman Sachs which were acting as lenders to Archegos and processed some of its trade forced the fund to sell shares to cover potential losses after the price of Viacom started to crash. It was clear on Monday that some other banks too were involved in Archegos credit sales.
Some people say that Goldman Sachs, Morgan Stanley, Deutsche Bank, Credit Suisse, and Nomura may collectively lose out on $6 billion with the fall of Archegos Capital, with Nomura alone bleeding more than $2 billion. According to some estimates, the loss to Credit Suisse could be in the range of $3-$4 billion.
Credit Suisse’s share tumbled 14% after it said that the losses due to its involvement with the Archegos fund would be significant and affect its first-quarter results. Nomura fell 16% after it said that it could take a $2 billion hit.
Why the collapse could not be prevented?
Archegos Capital management is a family office which is a type of hedge fund established by wealthy families to manage their money and provide related services to the family members. This could include tax, real estate as well as philanthropic ventures. Family offices are generally not regulated and do not have to register with US Securities and Exchange Commission (SEC). Due to this hedge funds like Archegos Capital Management do not have to provide quarterly financial reports on their equity holdings or give SEC any information on the size of their assets.
Archegos holdings were in the form of total return swaps, a financial instrument where the underlying stocks are held by large banks. This meant that Archegos did not have to disclose its large holdings, while if it had transacted in regular stocks it would have had to. The fund posts collateral against the securities rather than buying them outright with cash.
A margin call occurs when the market goes against a large, leverage position, forcing the hedge fund to deposit more cash or securities with its broker to cover any losses. Archegos had probably deposited a small percentage of the total value of the trades.
The fund was highly leveraged and did business with many banks which were likely unaware of the large positions held by other banks. When Archegos was unable to meet the banks call for more collateral to secure equity swap trades that they had partly financed and when the positions fell in value; the lenders sold big blocks of securities to recover what they were owed.
The chain of events that led to the massive unwinding is a reminder of the role the hedge funds play in global capital markets. A hedge fund short squeeze during a Reddit-fueled frenzy for Gamestop Corp. earlier this year led to a loss of $6 billion for Melvin Capital and the US regulators had to carry out scrutiny.
Globally family offices managed nearly $6 trillion in assets as of 2019.
Regulators are watching the event closely
In February hedge funds took losses on short positions during the run-up in GameStop Corp stock. The de-leveraging by hedge funds in March 2020 also contributed to some turmoil in the U.S. Treasuries. The high leverage in the case of Archegos with the complex nature of its derivatives trade fueled by low-interest rates has led to some concern of potential systematic risk. Archegos positions were highly leveraged with assets around $10 billion and positions held worth more than $50 billion. Hwang was known to have run a very concentrated and highly leveraged book.
The regulators in the United States, UK, Switzerland, and Japan are closely monitoring the situation. Wall Street banks spent the Monday briefing US regulators as the Securities and Exchange Commission summoned banks for meetings. The Financial Industry Regulatory body officials too quizzed the brokerages for any impact on their operations, credit risks, and any other threat.
Japan’s Chief Cabinet Secretary, Katsunobu Kato, said the government was carefully monitoring the situation at Nomura and that the Financial Services Agency would share information with the Bank of Japan.
Finma, Switzerland’s financial regulator said that it too was monitoring the situation.
The learning from the Archegos Incident
An important learning from the incident is the risk due to the large firms that are able to operate outside the purview of the regulators. Hedge funds are called hot money and regulated to some extent by regulators across the globe. But the family offices have been able to stay outside the framework and the recent episode has raised questions about the exemption as they are dealing in securities worth billions of dollars and pose systemic risk when left unchecked. As compared to this the regulated firms have position limits and the leverage they can use.