The Archegos Implosion
Archegos Capital Management, a family office run by Bill Hwang, blew up recently after its lenders forced it to sell its assets. The firm borrowed a lot of money from various financial institutions and held almost $110bn in stocks despite only having around $20bn. The aftermath has led several banks to suffer heavy financial losses, most notably Credit Suisse and Nomura.
Who is Bill Hwang?
Bill Hwang is a relatively unknown personality in the financial world, despite having a storied past. He is a Korean-American immigrant, having completed his undergrad in Economics from UCLA and an MBA from Carnegie Mellon University. After working for the famous hedge fund Tiger Management in the late 1990s, he started his own fund, Tiger Asia Management, which saw strong returns for its investors. However, in 2012, Tiger Asia became embroiled in a scandal over insider trading and paid fines to the SEC totalling over $60m. The firm and Bill Hwang were also banned from trading in Hong Kong. Following this, Bill Hwang decided to return all outside capital and changed its company name to Archegos. He is a devout Christian, having founded the Grace and Mercy Foundation, donating millions of US dollars every year to charitable causes.
What Is a Family Office?
A family office is a private wealth management advisory firm that serves ultra-high net worth investors. Similar to hedge funds, they invest in a variety of financial instruments from stocks, bonds to other more exotic products. They typically employ both long and short strategies to maximise returns. Each firm serves only one individual and their family, although there are multi-family offices that serve a few families in order to benefit from economies of scale. In Bill Hwang’s case, he is essentially investing his own money. As there are no external investors, the regulations imposed on family offices are much weaker than hedge funds. This allowed Bill Hwang to leverage his investments heavily through borrowing money from banks such as Credit Suisse and Goldman Sachs. This amplified his returns but exposed him to much higher risks as well.
How Did Its Lenders Force It to Sell?
To understand this, we first need to discuss the type of investment that Archegos was using. Archegos invested primarily in total return swaps, a type of investment based on its underlying securities (stocks in this case). Essentially, Archegos did not own any of the stocks but paid banks to purchase the stocks on its behalf. In exchange for receiving regular payments from Archegos, any profits made on the stocks would go to Archegos instead of the banks. This functioned similarly to a loan, and Archegos was required to pay banks collateral.
However, this had the benefit of allowing the investments made by Archegos to vastly exceed its assets, with the vast majority of its investment made through money generated from loans. Its leverage was 5:1, meaning that it invested 5 times as much money compared to what it had. This is a very risky position, and vastly exceeds the typical 1:1 leverage found in hedge funds that employed similar long/short strategies. If the prices of these stocks started to fall, banks would take on more risk as they owned the underlying asset, so they would demand more collateral from Archegos in what is known as a ‘margin call’. If this demand is not met, the banks would be free to liquidate Archegos’ assets as it had violated the terms of the contract.
Archegos’ investments were heavily concentrated in a few tech & media stocks such as ViacomCBS, Discovery Inc, and Baidu. When its portfolio started to fall, it was unable to meet the margin call. Many of its lenders, such as Morgan Stanley and Goldman Sachs sold off their holdings to recover their loans, which caused the stock prices to plummet even further. This caused other banks that waited such as Credit Suisse and Nomura to suffer substantial financial losses.
Apart from Archegos, three banks suffered significant losses: Credit Suisse at $4.7bn, Nomura at $2bn, and MUFG at $300m. Other banks such as Goldman Sachs, Morgan Stanley and Deutsche Bank emerged unscathed due to their faster selling. Credit Suisse suffered the most significant losses and has fired several senior executives, including the Head of Risk and Compliance and the Head of Investment Banking . The US Senate banking chair has also queried the Wall Street banks associated with Archegos, asking them for information on their relationship with the fund . Archegos flew under the radar because it was not subject to the same regulations as other financial vehicles as a family office. Its use of total return swaps also meant that it did not need to disclose its investments, since technically, the banks owned the underlying stocks. This incident has sparked debates on the regulations on market transparency on swaps and family offices in particular. Had the banks known the extent of Archegos’ dealing with other banks, they would likely not have entered into such risky positions.