Archegos: the questions nobody asks

Four-barrel gunThere has been a lot of press articles on the Archegos blow-up already, but many important questions have still not been asked.

 

The factual background

  • Archegos Capital Management is a family office, which manages the money of Sung Kook “Bill” Hwang since 2013. Hwang is a “Tiger Cub”, a former PM/Analyst from famous Tiger Management. Hwang was managing $500m of his own money, which he earned through his role as a portfolio manager in the previous decade.
  • Hwang started as a stock Salesman in early 90’s at Hyundai Securities. After a legal battle which started in 2009, Hwang and his firm Tiger Asia Management pleaded guilty in 2012 to insider trading & stock manipulation charges. They settled $44m with the SEC and HKD 45m with the HK Securities and Futures Commission.
  • Archegos is actually the new name of his old company Tiger Asia Management. The firm is based in New York, since Hwang was banned from trading in Hong-Kong in 2014, as well as other Asian markets in which he specialized.
  • Archegos held large concentrated bets in a few companies, notably ViacomCBS, Discovery, Baidu, Tencent and Vipshop.
  • Besides his own stock positions (already large), he also held stocks synthetically through swaps at prime brokers.
  • The primes didn’t know of the extent of his other prime relations and how large the positions were. The overall position was not $10bn, but more than $50bn – rumored to reach $100 bn.
  • The list of affected primes is increasing. Only JP and Deutsche seem to have escaped that wreckage. JP, because they refused to offer services to Archegos, and Deutsche, because they were quick to offload positions.

The unbundling

  • His large direct and synthetic acquisitions pushed the stocks up, often becoming one of the largest shareholders, just with regular stock ownership.
  • It is speculated that Hwang accepted, if not bet, on the stock rise since momentum traders would have to follow-up and purchase more shares. The stock would also attract activist retail traders (think “a new Gamestop!”)
  • ViacomCBS notably went up 300% in early 2021, surely thanks to its well-delivered online movie platform Paramount+, but surely also thanks to Hwang’s purchases.Viacom CBS 2019-2020
  • Unfortunately, late on March 22nd, ViacomCBS announced a $3 bn stock and convertible bond sale to cash in on its $100 stock price. The stock dropped 10% on the open.
  • Analysts announced stock downgrades. The stock loses another $20 in the next few days.
  • On March 25th, some of the prime brokers called Archegos on margin, or at least to sell some stocks to free capital and meet the margin call. Hwang adamantly refused. A posteriori, we can guess that he would never have freed enough capital, and that the stock sale would have generated more margin call, starting a snowball effect.
  • The primes talked to each other that day. Credit Suisse wanted to give him a few days. Goldman and Morgan Stanley seized the collateral instead.
  • On Friday, March 26th, and maybe during the weekend as well, Goldman sold $3.3bn of ViacomCBS collateral via block sales before the open. Deutsche quickly unwound $4bn of shares, notably to Marshall Wace. Morgan Stanley and Wells Fargo followed. The stock ended the day around $45, down ~50% from its top.VIAC downfall
  • On Monday, Zurich time, Credit Suisse announced that it faces a “highly significant loss”. Its share fell 21%. The rumor mill indicates $4-5 bn of losses. The firm, which recently took losses for the Luckin Coffee fraud, the Greensill Capital collapse, as well as a laundry list of other compliance issues, is now considering exiting its CRO and its investment bank head (respectively Lara Warner and Brian Chin). Closer to home for the shareholders, Credit Suisse has a CHF1.5 bn ($1.6bn) share buy-back in progress, and it is now at risk.
  • Nomura announced a $2bn loss. The stock barely moved.
  • JP Morgan estimates there is $10bn of loss spread between Wall Street banks.

The questions everybody asks

Archegos was estimated to have $10 bn of capital at the time of the events.

  • At the time of its wreck, the fund was rumored to have 50-100bn of exposure through swaps. That would be a 5x – 10x leverage on an indicated capital of $10 bn. That level of leverage is rarely offered by primes. Only the biggest, most diversified and excellent risk manager hedge funds like Citadel or Millennium are offered that type of leverage. A concentrated stock picker would be offered probably around 2x, at best 3x.
  • The reason Archegos was able to gain such high leverage, was because the primes didn’t know of the existence of so many other prime brokers (8?) supporting Archegos… in the same trades! There is here a structural issue at the confluence of confidentiality and leverage.
  • Hwang had a checkered past. He was caught manipulating stocks, and trading on insider information. He was a persona non grata in Asia. Why was he offered so much leverage in the US? We all know that primes prefer big famous PMs to smaller less-known PMs, but there are some risk-management issues to be learned here.
  • The fact that a fund was able to leverage so much – and costing so much to Wall Street – by hiding its multiple swaps is a glaring fault from a risk-management perspective.
    • The world of prime brokerage and swap trading is competitive, and banks do not disclose to each other how much leverage they extend to their clients (or even which clients they have).
    • In a world with low interest rates, the client-facing synthetic equity business is valuable. It is mathematically market risk-free (no VaR, only credit risk), while real money (institutionals and family offices) are considered very safe credit-wise. It is also profitable, with probably 20-40 bp margin, posted against a highly leverageable balance sheet.
    • Building prime brokerage activities is not cheap – systems, staff, compliance, support functions, etc, require top dollars. Banks have heavily invested in the activity, because prime brokerage becomes highly profitable when it reaches a critical mass of large hedge funds and family offices.
    • As a result, banks are bending over backward to attract and keep these top clients. This explains why Archegos was able to bend the rules and acquire extra leverage.
  • The Archegos situation is also a problem from a regulatory perspective.
    • There are no disclosure requirements for family offices, which are neither banks (heavily regulated) nor hedge funds (lightly and recently regulated). [Family offices are investment vehicles for a single investor. Because a 401(k) also fulfills that definition, a minimum of $100m in assets is usually considered as a minimum. If there are probably 50k individuals with that wealth, and 5-10k are managing their wealth themselves in a family office.]
    • Family and multi-family offices are now managing an estimated $6 trillion in assets. For comparison, the ETF business is now around $7.5 tn, and it is highly regulated and closely monitored.
    • Now, there is plenty of criticism already about the source of the wealth from wealthy families, or how they (mis-)manage their wealth, or how they influence the world… Some of these questions deserve to be asked if there is some wrongdoing. But I think also that people are entitled to some privacy. If Bill Gates wants to invest into farm land or Coca-Cola, that is his absolute right and none of our business. Which means regulating family office and private wealth like other asset managers is probably over-the-top.

LeverageThe questions nobody asks

Now, there are inconsistencies in the currently available information. Here are some of the questions which needs to be asked:

  • If Hwang started with $500m, where do the $10bn come from? Archegos is said to be a single-family office, and therefore has no other investors.
    • So, Archegos would have leveraged $500m into $10 bn of assets by trading stocks on margin. A 20x leverage? Unlikely.
    • Archegos accumulated gains from $500m to $10bn. A 20x gain over six years cannot happen unless you are highly leveraged. And if you are highly leveraged, the losses can be as fast as the gains.
    • Or a combination of both.
    • Anyhow, it is obvious that Archegos was highly leveraged.
    • And if you have any doubt, that leverage would have shown in the Sharpe and volatility monitoring executed by the primes.
  • We do not know the origin of the $10 bn he was indicated as managing. Was he managing money from other investors in his family office? If he was, he may be swimming with concrete shoes sooner than later.
  • We have no true idea of Archegos positions. Right now, we only hear rumors on positions and leverages. JP says there is $10 bn of losses between the various PBs. Where is that information coming from?
  • Hwang has managed a hedge fund. He knows the difference between long-only and long-short. Was he really long only, without market hedge, with his own money? Was he instead shorting stocks against his known longs, in a relative value play?
    • The $50bn would be the gross capital, aka 2x $25 bn. That reduces the leverage by as much. But we haven’t heard of any short wins/losses.
    • Also, even $25bn of S&P futures creates a lot of margin calls when the S&P goes from 2,500 to 4,000+…
  • The prime-brokers would have had a conversation on March 25th to decide between themselves what to do with the Archegos situation. Such a conversation between primes is hard to believe:
    • They are bound by confidentiality requirements. They simply are not allowed to discuss their clients’ positions to anybody (but regulators).
    • The PM would have had to agree to the call, if not be present on the call. Why would Hwang have agreed to that call?
    • Prime brokers talking between themselves of the overleverage? Credit Suisse asking for time? That’s not how it works. As soon as the PBs would have realized the extent of the leverage from the conversation, they would immediately have started liquidating the positions. The first one to rush to the door has a chance of making it alive. The 3rd or the 5th does not. It is unlikely they would discuss such a coordinated action, because they know that the other brokers were not going to respect the rule.
  • Negative $100 billHow is it possible that PBs would have lent billions based on Archegos STATED (not deposited) AUM? Primes lend based on the money deposited on their account. If Archegos say that it is worth $10bn, but deposits only $1bn, a prime would only leverage the $1bn, not the $10 bn. So how could we reach $50 or $100bn of TRS?
  • I have never met Hwang. Some of my contacts have. He doesn’t appear to be a perfect angel. Prime brokers are market professionals who have seen a lot, and they know how to read between the lines. He may be a messianic and charismatic presence (large charity donations, an openly strong God-believer, running bible groups…), but the insider trader and the rule bender are also visible. Settling $50+m with the top regulators for criminal charges is no small feat. How would so many prime brokers leverage someone with such a history and such a dubious character?
  • Also, primes do not decide, but calculate, the allowed leverage. They take into account the type of risks (concentration, availability of information…). They use complicated formula and processes. It would be a major faux-pas to over-ride those processes, aka senior management involvement.
  • Did the prime brokers really not know that he was building large positions through swaps? Maybe Hwang had good insider information and he was avoiding regulatory scrutiny by using swaps? If the brokers knew, then willful blindness could be another word to describe this situation.
  • Could it be, that primes got additional information about Archegos that has not been disclosed yet, say an investigative letter from authorities for instance, and decided to unwind the positions for that reason?

 

IMO, we do not have enough information at this stage to truly understand what happened. In other words, the SEC needs to open an investigation… if it has not started already.

This investigation will be private, but some statements will surely follow in the months and years to come…

 

 

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Written by Gontran de Quillacq

Gontran de Quillacq is an expert witness and a legal consultant. He is a recognized authority in options, trading, derivatives, structured products, portfolio management, hedge funds, mathematical finance, quantitative investment, strategy research and financial markets in general.

5 Comments

  1. James Hockenberry

    This is the best analysis of this debacle that I have yet read.

    Reply
  2. Alan P

    Great analysis. Thoughtful piece.

    Reply
  3. Erik Aarts

    A well-explained analysis. Thank you.

    Reply
  4. Paul Carroll

    Gontran
    Thanks for the analysis and sharing your perspective . Well done.

    Reply

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