Here are the complex bets at the heart of Archegos’ ‘unprecedented’ $ 30 billion margin call



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The losses that triggered the liquidation of positions approaching $ 30 billion highlight complex financial instruments used by European investors which are effectively banned in the United States but which could still spill over into the domestic market.

The so-called contracts for difference were at the center of some of the massive bets in the wrong direction made by Bill Hwang’s Archegos Capital Management, according to reports.

According to Bloomberg News, contracts for difference, or CFDs, were at the heart of some of the “unprecedented” deals executed by former hedge fund titan protégé Julian Robertson. Robertson founded the leading investment firm Tiger Management in 1980 and his investment descendants are affectionately referred to as Tiger Cubs.

CFDs are a kind of derivative instrument that allows traders to place a directional bet on the price of a security without actually buying or selling the underlying instrument, explained Julius de Kempenaer, senior technical analyst at StockCharts.com , to MarketWatch by email.

“It works a bit like a futures contract on, say, an index. The buyer and seller agree on the price of a transaction in the future. On the end date, or earlier if they decide to close out the position in advance, only the difference between the actual price and the agreed price will be settled. ”

“If the price goes up, the seller pays the difference to the buyer, and vice versa,” the analyst wrote.

The loosening of Archegos’ positions is said to have caused sharp declines last week in many stocks, including ViacomCBS Inc.
-6.68%
and Discovery Inc. DISCA,
-1.60%,
even though the larger markets have grown.

The StockCharts.com analyst explained that CFDs are leveraged bets, in which investors can use borrowed money at a fraction of the cost of the underlying asset, “typically around 10 to 20% depending on the volatility of the underlying market ”.

“That means you can get a position worth $ 1 million and only need $ 200,000 of margin. This allows you to build great positions very quickly without much impact on the market, ”he said.

Margin is the amount of money that a trader must initially put down as collateral when taking positions, and a margin call occurs when the market goes against these leveraged bets, forcing the investor to deposit more cash or securities to cover losses.

In addition to the leverage, sources reported that Hwang could have obscured his investment fund’s exposures by using multiple banks to execute the firm’s trades.

Credit Suisse Group AG and Nomura Holdings Inc. said they could suffer substantial losses from major liquidation transactions, but did not name Archegos.

Shares of Nomura 8604 listed in Tokyo,
-16.33%
fell more than 16% on Monday, a record drop in one day, while Credit Suisse’s U.S.-listed CS stock,
-11.50%
fell almost 12%.

The big banks hedge their exposures to these CFD bets by buying at least a portion of the actual shares in the market.

CFDs are not legal in the United States, but their use in other regions, particularly in Europe, may be something that regulators weigh when monitoring this margin call situation, Amy Lynch said, former SEC regulator and chairwoman of FrontLine Compliance, to MarketWatch in a Monday afternoon interview.

“Extremely risky” is how she characterized CFDs.

“It’s kind of like being able to get into a naked position,” she said, referring to bare bets where investors use derivatives to gain exposure to an investment without owning the underlying asset.

Lynch said companies like Nomura and Credit Suisse “can handle these amounts of losses”, but said the market was still concerned enough that “they should review their internal controls and practices around these instruments.”

On Monday, the market appeared to shake the event, with the Dow Jones Industrial Average DJIA,
+ 0.30%
ending at an all time high, while the S&P 500 SPX index,
-0.09%
virtually unchanged finish and the Nasdaq Composite Index COMP,
-0.60%
ended the session slightly lower.

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