The Archegos Debacle

On the 26th of March 2021, Archegos Capital Management came to the limelight for all the wrong reasons. The firm, hit by a margin call was forced to liquidate more than $20 billion worth of assets, erasing up to $35 billion in market valuation of various stocks in the process. Today let’s explore what is this debacle and how did it arise.

---

WHAT IS ARCHEGOS CAPITAL MANAGEMENT?

Archegos Capital Management was a New York-based family office that managed $10 billion worth of assets or possibly more in the US, Chinese, South Korean, and Japanese stock markets.

A family office is a loosely regulated, privately owned company that manages vast amounts of money for wealthy clans. Family offices are out of the regulatory scrutiny of the regulatory bodies like the U.S. SEC and Indian SEBI; hence they are covert, cost-effective, and sometimes multi-generational.

Archegos was created and run by a former Tiger Asset Management trader Bill Hwang. He is one of the many former Tiger Asset Management employees who built their successful hedge fund empires and came to be known as ‘Tiger Cubs’. Notably, Tiger Asia Management had previously pleaded guilty to insider trading of Chinese bank stocks in 2012 and paid a $44 million fine, and in 2014, Bill Hwang himself was banned from trading in Hong Kong for four years.

---

WHAT EXACTLY HAPPENED AND WHY?

Archegos Capital Management used financial instruments known as, swaps to build positions in the market. The key ingredient of this instrument is leverage.

Hwang ran a long-short strategy with exceptionally large leverage with the key component of this strategy being the use of Total Return Swaps. Under this agreement of Total Return Swaps, the firm would make payments at a fixed or variable rate to its brokers and in return, the broker would make payments to the firm based on the returns on the underlying assets. Through these swaps, the firm can borrow money from the broker, usually large banks, to take huge positions without putting up as much of its capital. This act of taking positions in the market, through the use of borrowed money is called leverage. And Archegos, due to being a family office, was able to take much more leverage than the amount allowed to regulated entities.

Reports also suggested that the company also made use of Contracts for Difference or CFDs, another leverage product that allowed the firm to make a bet on the direction of stocks, currencies, commodities with a margin.

With this leverage-based financial instruments-focused strategy, Archegos built sizable stakes in companies without the market knowing because the assets were held on its brokers' books, the huge banks like Credit Suisse, UBS Nomura, Deutsche Bank, Goldman Sachs, and Morgan Stanley.

It had a huge investment in Viacom CBS, Discovery Communications, Baidu Inc, and Tencent Holding. The fall in market prices of shares of these companies triggered margin calls, wherein an investor is asked to bring in more capital to cover the loss, and the failure to bring in additional capital forces the brokers to sell the shares that they hold on behalf of the investor. And this is exactly what happened in this case. After Archegos failed to meet the margin calls, all of its brokers started selling off the shares in a fire sale, which is essentially selling the shares at a low price and had to book the emerging losses in their books.

This large-scale selling of shares triggered a drop in value and all the stocks Archegos had invested in fell sharply.

This is why global banks are facing huge potential losses, with some like Credit Suisse even changing its top management due to this fiasco.

---

LEARNINGS FROM THIS DEBACLE

This whole situation has again raised the question of allowing such large firms to operate outside of regulatory purview and its risk.

These family offices, while being a part of the capital markets like other institutions, have been able to stay out of the regulatory framework and the systematic risk posed by allowing these large firms to deal in assets worth billions, without any checks on the magnitude of leverage that they hold or their overall positions, is huge.

In India, just like in the US, family offices do not come under the purview of the capital market regulators, and some experts believe that it is high time that they come under regulation as well to keep a check on their position limits, leverage, etc.