"How Bill Hwang used derivatives to fly under disclosure regulations and lost billions for global banks."
It was the type of story we thought we would never hear again after the global debt crisis of 2008, which itself was triggered by a meltdown in the derivatives market. But late in March of 2021, family office Archegos Capital triggered a massive fire sale in stocks after Archegos failed to meet margin calls on derivative contracts with global banks. JP Morgan estimates the total losses of banks involved in the Archegos debacle at almost US$10 billion. Just three banks, Credit Suisse, hardest hit with declared losses of US$4.7 billion, Nomura with losses of about US$2 billion, and Morgan Stanley with US$911 million in losses, account for about US$8 billion in losses. Japan’s largest bank, the Mitsubishi Financial Group, is expected to post US$ 300 million in losses.
Major risk management reviews and investigations have been announced at the two banks most affected by the Archegos’ unwinding and reviews by managements in other banks as well financial regulators around the world are likely to follow. They need to understand what happened and how to prevent it from happening again.
After the global credit crisis, regulators around the world responded with tighter controls and so did bank risk management offices. Certainly, Archegos is not the first financial debacle we have seen. Just in the last few months, we have seen hedge fund losses from GameStop and Greensill Capital. So far, while some hedge funds have closed down, no major bank seems to have sustained a financial hit large enough to threaten its existence. That is the good news.
However, clearly, there are holes in the system.
What happened at Archegos? First, Archegos is what is called a family firm, essentially an investment company that invests the money of one family, in this case, the funds of Bill Hwang. Estimates of the real value of Hwang’s funds range from US$10 billion to as much as US$20 billion in the early parts of March 2021. Analysts point out that had Hwang liquidated his positions in the early part of March, he would be sitting on as much as US$20 billion, a far cry from the US$200 million left from the fund he closed down in 2012. He grew his fund by betting on stocks.
Hwang did not bet on stocks merely by buying them. Instead, he bet on stock movement through derivatives. Analysts estimate that with these derivatives, Hwang’s real exposure was about US$50 billion. At the other end of these transactions were the banks that sold him these derivatives. When the stock prices went in the direction Hwang bet on, he made money. When they didn’t, he needed to put up cash to cover the differences. These are called margin calls. What happened in the last half of March was that Hwang’s bets went so spectacularly wrong that he couldn’t cover the margin calls. This forced the banks at the other end of the transaction to begin a massive selloff of stocks to cover their losses.
Essentially, these are the same as the selloffs financial institutions had to make to cover their bets on GameStop.
In the week of 26 March, major banks began selling billions worth of stocks. The Financial Times reported that Morgan Stanley sold over US$8 billion worth of stocks on 26 March. Bloomberg reported on 27 March that Goldman had liquidated US$10 billion worth of stocks in block trades. The Business Times reported that Goldman sold US$6.6 billion worth of shares of Baidu, Tencent Music and VIPshop holdings before the US market opened 26 March and that subsequently, Goldman sold US$3.9 billion worth of shares in Discovery, ViacomCBS, Farfetch Ltd., iQIYI Inc and GSX Techedu Inc.
In the week of 26 March, many shares had taken massive hits. US-listed shares of Baidu and Tencent Music dropped 33.5 percent and 48.5 percent respectively in the week before the disclosures, and shares in ViacomCBS and Discovery had dropped 27 percent each on the Friday preceding the disclosures.
These share drops were not the end of the financial fallout. Nomura shares closed a record 16.3 percent down the day after its disclosure. Credit Suisse shares fell 14 percent, its largest one-day drop in a year. Deutsche Bank shares declined 5 percent, UBS dropped 3.8 percent, Morgan Stanley slipped 2.6 percent, and Goldman Sachs group lost 1.7 percent.
Nomura had been enjoying a stellar financial year until the Archegos disclosure. Nomura has already announced tightened financing for some of its hedge fund clients.
For Credit Suisse, the Archegos disclosure would result in another quarter of losses after having reported a US$450-million impairment after York Capital Management announced the winding down of its European hedge funds. The pressure on Credit Suisse is particularly high as it is already dealing with the fallout from its involvement with the failed supply chain finance company, Greensill Capital. The company has announced the departure of John Dabbs and Ryan Nelson, heads of the banks’s prime brokerage business, the unit involved with Archegos. Credit Suisse had also previously announced the departure of Lara Warner, Chief Risk and Compliance Officer, and Brian Chin, Chief Investment Officer.
So far, no larger economic fallout seems likely, stemming fears of Archegos exposing a larger, more systemic problem. Another possibility is that the Archegos’ unwinding occurred before too many deals had dropped through the holes in the regulatory and management infrastructures in global banking that had allowed Archegos losses to occur.
Meet Bill Hwang
Archegos was established by Bill.Hwang in 2013. In 2012, Hwang had shut down Tiger Asia Mgt after pleading guilty to US insider trading. As part of tightening on insider trading, Hwang also received a 4-year ban from trading securities in Hong Kong in 2014.
Despite his checkered past, Hwang was able to purchase derivative instruments from multiple global banks to the tune of a total estimated exposure of US$50 billion, as much as five times his declared assets.
Hwang’s Archegos was unregulated because it is a family firm investing personal funds. He was able to skirt disclosure laws on stock ownership because he was purchasing derivatives not stocks. This meant that the amount of Hwang’s total exposure to certain stocks was not public knowledge.
This exposes holes in current regulations, both in terms of derivative disclosures as well as of family firm regulations.
The banks on the other side of the deal are regulated. They can and would be right to argue that they did not violate the law by selling CFDs to Hwang. The question though is whether they were using good judgment in taking significant exposure to someone with a significant and global history of trading irregularities.
Over a decade after the global credit crisis, derivatives continue to create problems. And those who should know better still seem to behave otherwise.
Readers can email Maya at email@example.com. Or visit her site at http://integrations.tumblr.com.
Errors. Apologies for errors that escaped my review in last week’s column. I had initially meant to write about Lazada, Shopee and Zalora and decided very late to limit it to Shopee and Lazada. As a result, editing errors creeped in ascribing some of Zalora’s early activity to Shopee. Zalora is the company that focused on fashion and opened a storefront in Makati. Mea culpa. The correct version of the article can be found on my FB page: Integrations Manila.