How Hwang’s Archegos blinded global banks

(Bloomberg) – Shares of the “old media” company soared nearly 300% in a matter of weeks, and small investors were abuzz with the theories: It’s undervalued, like GameStop! It’s a takeover target!

However, inside the major Wall Street trading companies, some executives had some idea of ​​the cause of the move. A trading whale – Bill Hwang’s Archegos Capital Management – was building a massive position in ViacomCBS Inc.

Banks around the world continued to give Hwang the leverage he needed to acquire more and more stocks. What they couldn’t see, according to people familiar with the situation, was the full extent of his bets. He stealthily amassed $ 10 billion from Viacom and colossal positions in a few other companies.

Gaps in oversight and risk management are one of the reasons banks were so vulnerable when the Viacom bet collapsed and Archegos imploded last week.

Highlighting the chaos of the escalating situation, representatives of Credit Suisse Group AG made a suggestion during their meeting last week to deal with the reality of such an exceptional margin call and consider ways to mitigate the damage: maybe wait and see if his actions recover? Viacom, some have noted, looked artificially low after going above $ 100 two days earlier.

Still, it was Hwang’s own drives that helped make Viacom the best performer of the year in the S&P 500, forcing benchmark investors and exchange-traded funds to buy as well. Without creating this momentum for him, Viacom and its other positions had little hope of bouncing back.

At several points in these exchanges, bankers implored Hwang to give himself leeway by selling stocks and collecting cash to put down collateral. He did not want to move, said people who attended the meetings.

Read more: One of the world’s greatest hidden fortunes is wiped out in days

Now, as regulators assess the fallout, Wall Street’s habit of lending to lucrative clients with few questions is garnering unwanted attention.

Hwang’s family office has built positions in at least nine stocks large enough to rank him among the largest holders, fueled by a level of bank leverage that would have been unusual even for a hedge fund.

Archegos was able to place outsized bets using derivatives and, as a private company, avoided the disclosures required of most investors. Almost invisibly, he has amassed a portfolio that some people familiar with his accounts estimate to be as high as $ 100 billion.

As more details emerge as to how banks have been so instrumental in helping Archegos increase these bets, the blind spots that prevent the industry from effectively managing the risks it creates are growing. more obvious.

Read more: SEC opens investigation into Archegos transactions that sparked rout

Already, regulators are privately dropping hints of new rules to come. Securities and Exchange Commission officials have signaled to banks their intention to place a higher priority on information about hedge fund transactions, while finding ways to manage risk and leverage.

Senior finance officials recognize that a crackdown in one form or another, whether on borrowing or transparency or both, is inevitable.

While some of these companies have revealed the financial impact of their role in the Archegos collapse, none are willing to comment on how or why they made Hwang such a force in the market. Hwang declined to comment through a representative.

Limited visibility

What is clear from those involved in the margin call and what followed is that the financiers of Hwang, the prime brokerage units of Nomura Holdings Inc., Goldman Sachs Group Inc., Morgan Stanley, Credit Suisse and others had clues as to what Archegos was up to. These companies of course knew the trades they had financed and also had some visibility over all of its borrowing, the people said.

But lenders couldn’t see that Hwang was taking parallel positions in multiple companies, stacking more leverage on the same few stocks, people said. While most clients insist on such opacity, it has obvious implications for a lender’s ability to manage risk: unwinding a series of large, leveraged bets placed by a single account is one thing; to do it when competing banks liquidate the same positions held by the same client is quite another.

On March 25, Hwang’s top brokers met again and discussed the possibility of temporarily stepping down to let tensions ease, according to people who participated in the talks. But any attempt at solidarity turned out to be short-lived. On that day, some sent Archegos notices of default, paving the way for the sale of its positions.

Analysts at JPMorgan Chase & Co. estimate that some banks could end up absorbing up to $ 10 billion in combined losses.

Read more: Credit Suisse offer on Archegos Fix ends with bank brawl

“Hopefully this will cause the major brokers of regulated banking organizations (and their supervisors) to reassess their relationships with highly leveraged hedge funds,” tweeted Sheila Bair, former president of the Federal Deposit Insurance Corp.

Hwang had already gone through a crisis. In 2012, he filed a guilty plea on behalf of his hedge fund to a wire fraud charge, and he resolved the related insider trading civil lawsuits without admitting or denying wrongdoing. Archegos is the family office that he formed after the dissolution of this company, Tiger Asia Management.

The major brokers began to line up to help the new business. Morgan Stanley was one of his first supporters. Deutsche Bank AG signed him as a client at the behest of at least one senior executive who was not disturbed by insider trading and did not believe Hwang had done anything wrong, according to a familiar person. with this decision.

One company resisted the lure. Archegos approached JPMorgan between 2016 and 2018 and was turned away, according to a person briefed on the situation. At the time, JPMorgan was still reorganizing the equity prime brokerage unit it acquired with Bear Stearns during the 2008 financial crisis. Good luck or not, the bank dodged a bullet.

Goldman Sachs was also selected. For years, the heads of his equity division tried to open an account for Hwang, and the compliance department always refused. Goldman finally jumped on board in the last few months of 2020, enough time to expand his business with Archegos and land amidst the chaos of the past week.

Settlement of swaps

This activity, at Goldman and everywhere else, was swaps. Swaps are agreements between a bank and its customer that are settled based on changes in the prices of underlying assets – such as Viacom shares.

One of the advantages of swaps is that they allow large investors like Hwang to create positions in a stock anonymously. A prime broker would buy the shares and present himself as the beneficial owner when in reality Archegos bore the economic risk.

To execute such a swap, Archegos would put a percentage of the value of the cash position as margin. The rest of the trade would be financed by the prime broker.

Since swaps are settled daily with gains and losses offset, Archegos also had to issue a second type of collateral called a variation margin if the value of its portfolio fell. If its value increased, the bank would pay the company in cash.

One feature that protected Hwang’s lenders was the right, in case he could not answer a margin call, to seize all collateral on his swap accounts and sell the positions. This is what happened last week after the fall of Viacom.

Hwang’s purchase helped push the stock above $ 100 for the first time, giving his position a market value of around $ 10 billion. The second largest holder was indexing giant Vanguard Group, with a 40% smaller stake, according to data compiled by Bloomberg.

Late on March 22, Viacom announced a sale of $ 3 billion of shares and convertible debt. Over the next two days, Viacom shares plunged 30%, pushing Archegos above its margin limits and raising alarms among its major brokers. In urgent meetings, they finally realized the full extent of his bets.

Hwang’s refusal

Initially, some of Hwang’s lenders were reluctant to abandon it. The group begged Hwang to reduce his positions, a move that would force him to suffer some casualties. He refused.

At the close of trading on March 25, a Thursday, Viacom was down an additional 5.3% to $ 66.35. In one of the emergency sessions, Credit Suisse representatives suggested some sort of standstill deal – delaying the sale of Hwang’s collateral to see if the stock would trade.

On Friday, well before the 9:30 a.m. opening in New York City, Goldman was already offering $ 3.3 billion of Archegos holdings in massive blocks. Morgan Stanley and Wells Fargo & Co. quickly followed suit. Monday in Zurich, Credit Suisse revealed that it was facing a “very important” loss, linked since to Archegos and which is expected to reach billions of dollars. Nomura could lose $ 2 billion.

Read more: Deutsche Bank dodged Archegos with a quick sell of $ 4 billion

“Risk controls are still not where they should be,” David Herro, one of Credit Suisse’s major shareholders, said Wednesday in an interview with Bloomberg TV. “I hope this is a wake-up call to accelerate the necessary cultural change in this business.”

The SEC has already opened a preliminary investigation into Hwang’s transactions and is calling on other large investors to inquire about their use of swaps and access to leverage from blue chip brokers. A regulatory shadow hangs over the industry.

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