Archegos Capital Blowup could open a “ regulatory piñata ”
Archegos Capital, the heavily indebted family office of former Tiger Cub Bill Hwang, is said to have caused huge losses in a handful of stocks, including ViacomCBS and Discovery, which debuted last Friday. Now, the new chairman of the Securities and Exchange Commission, Gary Gensler, and other global regulators are considering what to do to avoid a similar implosion.
The stock collapse impacted six banks that lent money on margin to Hwang’s family office, including Goldman Sachs, Morgan Stanley, Credit Suisse and Nomura. The chaos apparently started when Hwang couldn’t make his margin calls. Banks began selling shares of the companies on Friday, rocking the markets and sending investors in a tail swing to figure out what was going on.
Even as more details emerge about the bets Archegos has taken in recent months, one of the main risks that family office investments posed to the market was the risk of a single stock imploding, according to Andrew Beer. , member of the management of quantitative investment company Dynamic Beta. He explained that the biggest hedge funds in particular have increasingly focused on the same names over the past decade. The situation of Archegos illustrated these risks in real time. According to Beer, regulators and the market are asking many questions, such as whether banks increased high-value loans via swaps against single stocks that had just doubled or tripled in a year or less, as well. that dollar amount of loans and swaps while the underlying price of the stock rose.
“It’s a regulatory piñata,” Beer said.
Archego’s exposure to stocks like Viacom has been masked by holes in the US regulatory regime, according to Eitan Hoenig, a partner at boutique law firm Kluk Farber Law in New York City. Press reports suggest that Archego used total return swaps to gain exposure to stocks, rather than owning them directly. Even if that amounted to borrowing a lot of money and buying stocks, Archego didn’t have to provide transparency to regulators or comply with margin lending restrictions.
Hoenig said there is one world of rules and margin restrictions for investors who hold securities and another for investors who gain exposure through complex derivatives.
“I would expect people to say, ‘Wait a sec, we have a set of rules on how you make margin loans when people actually own the stocks to make a leveraged bet on a. individual action, ”he said. “The point of the margin lending rules is that we want to limit speculation and we want to limit people who sell on a margin call and the action goes crazy, just like Viacom did. It is much easier for a large institution with blue chip brokerage relationships to use synthetic margin loans than it is to make actual margin loans based on real securities. ”
Marlon Paz, head of broker-brokerage regulation and compliance practice at Mayer Brown, believes the issues fall into two categories: investor protection and systemic risk.
Although family offices are generally far from major investors, they still deserve protection, he said. “You have a leveraged family office,” he said. “The number is mind-boggling. I would say that the SEC will be looking closely at the question of the level of protection that a financial intermediary owes to family offices. “
Paz, who worked at the SEC during the financial crisis, expects regulators to look at Regulation Best Interest, or Reg BI. “I’m saying Reg BI is going to have to be revisited to determine where a family office fits: retail or institutional client,” he said. “If it’s retail, is it in the best interest of a family office to have multibillion leverage?”
Then there is the systemic risk. The Archego saga illustrates how a family office could inject a lot of counterparty risk into the system in the event of certain obligations defaulting, putting banks that have lent money to the family office at risk. In part, that’s because family offices aren’t limited in the amount of leverage they can use, Paz said.
“I suspect that regulators will review the margin requirements applicable to market participants to ensure that accounts have adequate collateral,” Paz said. “The margin rules that apply to certain family offices will probably be reviewed from the point of view of systemic risks. Can we put a cushion so that in the event of a shock, the financial markets can absorb the blow? “
Regulators have already taken steps to investigate what happened. According to Financial Times, the Securities and Exchange Commission and the Financial Conduct Authority of the United Kingdom have asked the banks involved in Archegos to provide information.