Margin call of the wild
Archegos, a family office, brings Nomura and Credit Suisse big losses
More bad news may follow. But the episode already raises disquieting questions
Before friday March 26th, few people may have heard of Archegos Capital Management, an investment vehicle run by Bill Hwang, a former hedge-fund trader with a chequered past.
But it has emerged as the entity behind a fire sale of at least $20bn-worth of equities, which roiled stockmarkets on an otherwise unremarkable Friday and has left at least two global banks—Credit Suisse and Nomura—facing multi-billion-dollar losses.
Financial regulators in America and Europe will have a say before the affair has run its course.
The plotline has already taken shape. Archegos is a so-called family office.
It manages the private wealth of Mr Hwang, who once worked for Tiger Management, a celebrated hedge fund.
One of Archegos’s strategies was long-short equity.
The main idea is to be indifferent to the direction of the overall market by betting that the share prices of some stocks will rise while the prices of other stocks fall.
The hope is that the longs do better than the shorts.
But when markets are volatile the strategy can come unstuck.
This is what seems to have happened to Archegos.
The first sign of trouble came that Friday when Goldman Sachs and Morgan Stanley, two Wall Street behemoths, began selling large blocks of shares for an unnamed client who had missed a margin call—a demand for more collateral to cover losses on trades that had gone awry.
The stocks that were forcibly sold might best be categorised as “second-tier tech”.
They included Baidu, a Chinese search engine, and Viacomcbs, an American media conglomerate, with a streaming service that gives it the flavour of a faddish tech stock.
Their prices crashed under the weight of the selling.
The price of Viacomcbs shares, for instance, fell by more than a quarter.
By Sunday March 28th it had emerged that the mystery client was Archegos.
More familiar names were caught up in the drama.
On Monday Credit Suisse said it was in the process of liquidating the positions of a client that had defaulted on margin calls, and that the related losses would be “material”.
Unofficial estimates put these at $3bn-4bn.
Nomura, a Japanese bank, said that it was on the hook for about $2bn, possibly more if stock prices fell further.
These are significant losses. If not quite a lost limb, they amount to more than a flesh wound.
The banks’ share prices tanked.
The full reckoning will only become clear over time.
But evidently Nomura and Credit Suisse were slower to pull the plug than their American rivals, after an attempt to co-ordinate an orderly unwinding of Archegos’s positions failed.
By making the margin call on Archegos early, and then liquidating positions quickly, the Americans seem to have limited the damage to themselves, but left the others nursing bigger mark-to-market losses.
The fire sale raises some disquieting questions.
How was Mr Hwang, a little-known figure, able to run up such big losses?
Leverage played a big part.
Why then was he able to lean so heavily on Wall Street to enhance the size of his bets?
What makes this even more puzzling is that Mr Hwang had already blotted his copybook.
In 2012 he pleaded guilty to charges of insider trading.
One answer is that banks are desperately searching for profits.
Rules drafted after the global financial crisis make it expensive for Wall Street banks to trade on their own account.
The days when they could make much money from slow-moving, unleveraged asset managers—the “long-only” crowd—are a distant memory.
Such investors mostly buy and sell stocks cheaply on electronic platforms.
So Wall Street banks increasingly rely on fees and commissions from fast-trading hedge funds or family offices that act like hedge funds, such as Archegos.
Fees on bespoke derivatives, such as equity swaps and contracts for difference, are especially attractive to the brokerages.
The appeal for the fast-money hedge-fund crowd is that such derivatives allow them to magnify their positions.
They can make large bets without having to put up lots of their own capital upfront.
In short, Wall Street can’t easily make money out of people who do not take rash bets. But people who make rash bets can lose you money, too.
It is probably not a coincidence that Credit Suisse and Nomura are based in countries (Switzerland and Japan, respectively) where long-term interest rates have been stuck near or below zero.
With few opportunities to make money from lending at home, they turned to Wall Street for excitement.
Unfortunately for their shareholders, they found it.
Parallels are naturally being drawn between Archegos and ltcm, an ill-fated hedge fund.
In 1998 ltcm was prevented from blowing up itself and the banking system by the Federal Reserve, which co-ordinated a bail-out by its Wall Street brokers.
ltcm, too, was afforded breathtaking leverage by its brokers, who were dazzled by its principal shareholders, who included John Meriwether, a star trader formerly at Salomon Brothers, and Robert Merton and Myron Scholes, Nobel-prizewinning economists.
It appears that several of the banks that acted as Mr Hwang’s brokers tried to come to a standstill agreement, of the kind that the Fed mediated for ltcm, in order to avoid a fire sale of the stocks they held to hedge their exposure to Archegos.
Those discussions are now the subject of regulatory scrutiny.
The tentacles of Archegos evidently do not stretch anything like as far into the financial system as ltcm’s.
The wider damage from the Archegos affair has so far been limited.
Archegos might be a one-off mishap, albeit a large one.
But it is not too much of a stretch to link it to some recent market themes.
Since November there has been a general shift away from tech-and-media stocks, which profited greatly from the stay-at-home economy, towards cyclical companies, such as banks, airlines and industrial firms, which benefit from reopening.
Archegos may well have been at the wrong end of this, at times violent, rotation.
Events are moving unusually fast in the world economy and in financial markets.
And when events move fast, some things get broken.
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