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COMMENTS ON THE IMPLICATIONS OF THE ARCHEGOS DEBACLE FOR THE BANKING SECTOR
Please find hereafter some brief comments on this event. Note that we do not yet know all the details surrounding the events at the time of this writing. 1) The background Archegos (hereafter "the Fund") was a hedge fund disguised as a family office. The Fund was highly leveraged and may have had equity positions of nearly USD 50bn with only about USD 10bn in equity. This leverage was provided by the use of derivative instruments called "contracts for differences" or CFD's. The Fund was run by Mr. Hwang, a former Tiger Management portfolio manager. Mr. Hwang had been found guilty in 2012 of insider trading and had settled with the US Securities and Exchange Commission for a fine of USD 44mio. Archegos had a concentrated fund in perhaps 10 to 20 positions, mainly in Chinese technology companies (Tencent Music, Baidu, etc.) as well as US media shares (Viacom, Discovery). It seems that the more the stocks of the Fund increased in value, the more the Fund added to its positions by increasing leverage. 2) What happened? On tuesday 23rd of march, one week ago, Viacom that was one of the largest holdings of the Fund, issued new shares for an amount of USD 2.65bn. This secondary issue was led by Morgan Stanley, Citigroup, Goldman Sachs, JP Morgan, Mizuho, and Siebert Williams Shank & Co. Viacom management took advantage of the sharp increase in the share price of the company from USD 40 in january 2021 to over USD 100 in march 2021 to raise money to finance new investments in streaming. This issue of new shares of course led to a sharp decrease in Viacom shares, triggering the first margin calls for the Archegos fund. The Fund had therefore to start selling positions which in turn triggered even more losses. By wednesday 24th of march, the banks that had provided the leverage to Archegos began to liquidate the positions of the Fund. On thursday 25th of march, Credit Suisse tried to organize a conference call with other banks to try to manage the liquidation of the Fund's positions in an orderly manner, but without success. On friday 26th of march, the banks were in a frenzy to liquidate the positions of the Fund as quickly as possible. This led to the Fund’s bankruptcy, and the Fund ended up with no equity, owning money to many banks. The extent of the losses for banks is estimated between USD 5bn and USD 10bn. While certain banks were able to close out the positions of the Fund without any losses or with immaterial losses (Wells Fargo, Goldman Sachs, Deutsche Bank), others are facing much greater losses. Nomura is rumored to have losses of USD 1bn to 2bn, while Credit Suisse could face losses of nearly USD 5bn 3) Why is this shocking? This new blow-up of a hedge fund is shocking for many reasons. 1) Banks were again too greedy and forgot the lessons learned in the aftermath of the bankruptcy of the Long-Term Capital Management fund in 1998. They prioritized short term revenues instead of prudent risk management. 2) The banks were so "hungry" for business that they accepted to trade with an individual, Mr. Hwang, that had been condemned for insider trading. The so -called “client acceptance processes” and “due diligence processes of banks” appear to be a joke. 3) The banks were so "hungry" for business that they accepted to trade with Archegos, without having the complete view of the Fund's positions, nor the view of the leverage of the Fund. This is a failure in terms of risk management. Providing leverage to a Fund that has a leverage of 4x its assets, invested in volatile stocks is both irresponsible and unacceptable. 4) Bank regulators and bank auditors were once again blind, not having questioned the dealings of the banks that they are supposed to regulate, respectively audit. The failure of Archegos is a failure of the regulators' oversight and a failure of auditors. 5) The banks once again are not able to manage conflicts of interest. What can one think of the banks that participated in the new share offering of Viacom, selling to investors shares at USD85 per share that less than a week later are trading at half of that price? 4) What happens next? The losses of USD 5bn to USD 10bn are manageable by banks that have seen their profitability sharply increase since mid-2020. The losses on Archegos are NOT going to trigger any systemic risk event. This is not 2008. No banks are going to go bankrupt, and the clients' money is safe at Nomura, Credit Suisse, and others. There is NO need for clients to fear for their money or to consider changing bank. Nomura and Credit Suisse remain highly capitalized and will end up with a bad year 2021, but nothing more We will of course see changes in the management of banks. What we may not see, unfortunately, is a better coordination among regulators and a more proactive approach to regulation. Sadly, it seems that regulators are there only there once the problems have occurred and are not able to prevent such issues. Many individuals will now cynically point out to the fact that the banks typically do a lot of work before providing a small loan or take long periods of time to on-board new clients, while accepting to work with a convicted portfolio manager without any kind of due diligence on the Fund he manages. I remain at your disposal for any further questions or comments.