Bill Hwang, Founder of Archegos Capital Management, surrounded by the investment banks which accumulated more than $50 billion in credit exposure (Source: Financial Times)
May 8th, 2021
Investor Bill Hwang caused a massive shockwave through Wall Street back in March when his firm Archegos Capital Management, along with many financial institutions, began selling off massive chunks of Chinese and American companies.
Archegos was a family office that managed Bill Hwang’s personal assets. The ex-Tiger-Asia Management founder was making headlines back in 2012 after he reached a $44 million settlement with the Securities and Exchange Commission (SEC) concerning insider trading.
Following the closure of Tiger Asia, Hwang opened his family office which managed $10 billion of family money. Compared to a hedge fund, family offices are less regulated and do not get as much attention from the media.
It didn’t take long for Hwang to get into more trouble though and the recent downfall of Archegos cost him gravely. Bloomberg reported that he lost $20 billion within 2 days and the collapse sent devastating ripples to several big banks.
The downfall started on Friday, March 26th after investors discovered Archegos had defaulted on loans used to build a $100 billion portfolio and finally caught onto the firm’s strategy. Archegos obtained their financial positions with total return swaps which are, according to The Wall Street Journal, contracts from prime brokers (typically Wall Street banks) “that allow a user to take on the profits and losses of a portfolio of stocks or other assets in exchange for a fee.”
These swaps are a type of loan and enable investors to take on stock positions without having to provide the money upfront. The swaps also allowed Archegos to not have to meet additional regulations or disclosures of quarterly earnings because they were not technically the owner of the asset.
The SEC requires that investors holding more than 10% of a company’s securities be seen as company “insiders” and subject to additional regulations. The anonymity obtained from the swaps was how Archegos was able to acquire a 10% stake in companies like ViacomCBS (NASDAQ: VIAC) and Discovery (NASDAQ: DISCA) while simultaneously staying under regulators’ radar.
Following massive losses in their portfolio, Archegos had to meet a margin call which means they either needed to deposit more money into their account or sell their assets. Once Archegos failed to meet the margin call, the prime brokers began liquidating billions in the various stocks that were linked to Archegos’s total return swaps.
The sell-off caused Discovery shares to drop by 27%, or $15.85, and ViacomCBS stock to drop by 27%, or $18.12. Chinese entertainment company IQIYI (NASDAQ: IQ) also saw a decline of 13%.
Other companies, such as luxury retailer Farfetch (NYSE: FTCH), Chinese tutoring company GSX Techedu (NYSE: GSX), Baidu (NASDAQ: BIDU), and Tencent Music Entertainment Group (NYSE: TME), all experienced the quick sale of their stock due to the Archegos debacle.
Banks that traded with Archegos were also affected because they were the prime brokers for the total return swaps or involved with Archegos in some other capacity, but some were impacted less than others.
Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), and Deutsche Bank (NYSE: DB) were the first ones to move on liquidating their assets tied to Archegos and able to minimize their losses. However, banks like Credit Suisse (NYSE: CS), UBS (NYSE: UBS), and the hedge fund Nomura (NYSE: NMR) were not as lucky.
A financial mess piled up because these banks enabled Archegos to forego highly leveraged investments without requiring a substantial amount of collateral. Some of them offered leverage 10 times or only asking for collateral worth 10% of the sums borrowed. Risky strategies often end in disaster in the world of finance and this one is no different.
Worst hit were Credit Suisse, which reported losses of $4.7 billion, and Nomura, which reported a total loss of $2.85 billion. At both companies, senior executives were laid off and bonuses for directors were slashed as a result of the fire sale. Morgan Stanley and UBS were also hit hard by the Archegos scandal reporting losses of $911 million and $774 million, respectively.
These banks are now seeking compensation for the $10 billion in losses and Archegos is preparing for insolvency. The banks are also reviewing their processes toward financing hedge funds and family offices and searching for any practices susceptible to potential risk. They are also tightening their credit lines and adjusting their margin requirements to minimize adverse exposure.