Archegos fallout highlights hidden risks in bank systems

Regulators looking to tighten restrictions to reduce unwarranted exposure to hedge funds

The Credit Suisse Group headquarters in Zurich. Nomura Holdings and Credit Suisse Group, the two lenders hit hardest in the Archegos debacle, have started to curb financing in the business with hedge funds and family offices. PHOTO: BLOOMBERG
The Credit Suisse Group headquarters in Zurich. Nomura Holdings and Credit Suisse Group, the two lenders hit hardest in the Archegos debacle, have started to curb financing in the business with hedge funds and family offices. PHOTO: BLOOMBERG

NEW YORK • The collapse of Archegos Capital Management, an investment firm that few even on Wall Street had heard of until it imploded last month, is changing a lucrative, decades-old part of global banking.

Nomura Holdings and Credit Suisse Group, the two lenders hit hardest, have started to curb financing in the business with hedge funds and family offices. European regulators are studying risks banks are taking when lending to such clients, while in the United States, the authorities have started a preliminary probe into the debacle.

Together, steps taken from Washington to Zurich and Tokyo could portend some of the biggest changes since the financial crisis to a cornerstone of global banking known as prime brokerage. Typically housed in the equities units of large investment banks, these businesses lend cash and securities to the funds and execute their trades, and the relationships can be vital for investment banks.

But the collapse of Archegos, the family office of former hedge fund trader Bill Hwang, has underscored the risks banks are taking with these clients, even when their loans are secured by collateral. Credit Suisse has been the worst-hit so far, taking a US$4.7 billion (S$6.3 billion) write-down in the first quarter.

The lender, one of the biggest prime brokers among European banks, is now weighing significant cuts to its prime brokerage arm in coming months, people familiar with the plan have said.

It has already been calling clients to change margin requirements in swap agreements - the derivatives Mr Hwang used for his bets - so they match the more restrictive terms of other prime-brokerage contracts, people with direct knowledge of the matter said. Specifically, the bank is shifting from static margining to dynamic margining, which may force clients to post more collateral and could reduce the profitability of some trades.

Nomura, which is facing an estimated US$2 billion from the Archegos fiasco, followed suit, with restrictions including tightening leverage for some clients who were previously granted exceptions to margin financing limits, Bloomberg reported on Tuesday. Japan's biggest brokerage is examining the cause of the possible losses though it's too early to say how it might impact earnings, an executive at the firm said last month, asking not to be identified.

Mr Hwang's family office built positions in at least nine stocks that were big enough to rank him among the largest holders, fuelled by bank leverage that would have been unusual even for a hedge fund. Archegos was able to place outsize wagers using derivatives and, as a private firm, avoid the disclosures required of most investors. Almost invisibly, he accumulated a portfolio that some people familiar with his accounts estimate at as much as US$100 billion.

While Mr Hwang's financiers had clues as to what Archegos was doing and the trades financed, they couldn't see that he was taking parallel positions at multiple firms, piling more leverage onto the same few stocks, according to people familiar with the matter.

In the US, regulators are already privately dropping hints of new rules to come. Securities and Exchange Commission officials have signalled to banks that they intend to make trading disclosures from hedge funds a higher priority, while also finding ways to address risk and leverage.

"Hopefully this will cause the prime brokerages of regulated banking organisations (and their supervisors) to reassess their relationships with highly leveraged hedge funds," said Ms Sheila Bair, a former chairman of the Federal Deposit Insurance Corp, on Twitter.

In Europe, the top banking regulator has asked some of the bloc's largest banks for more information on exposure to hedge funds, people familiar with the matter said. While checks by the European Central Bank on lenders like Deutsche Bank and BNP Paribas are standard practice after such a disruptive event, they underscore regulators' concern even as most euro-region banks skirted big losses. "There is a need to scrutinise the reasons why the banks enabled the fund to leverage up to such an extent," ECB executive board member Isabel Schnabel told Der Spiegel last week. "It is a warning signal that there are considerable systemic risks that need to be better regulated."

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on April 15, 2021, with the headline 'Archegos fallout highlights hidden risks in bank systems'. Subscribe