As Wall Street shakes, Archegos’ fire sale raises big questions about regulation

American flags hang on the facade of the New York Stock Exchange (NYSE) building in New York on January 28, 2021.

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The different fate of the big banks due to the consequences of the collapse of Archegos Capital Management raises serious questions for the global regulators, according to experts.

Archegos’ forced liquidation of several of its positions sparked a fire sale of a number of US media stocks last week.

Nomura and Credit Suisse announced on Monday that they would face “substantial” losses after the multi-billion dollar family office defaulted on margin calls last week. Both banks had served the beleaguered hedge fund as prime brokers.

Broker colleagues Goldman Sachs, Deutsche Bank and Morgan Stanley were able to get away with it relatively unscathed, however, as they had already unloaded positions related to their margin calls from Archegos. The margin call defaults are estimated to have cost the banks around $ 6 billion in total.

Several banks reportedly communicated with each other through the Archegos squeeze. Some unload their positions in time, while others hold the bag in hand.

Former SEC attorney Mark Berman said regulators were looking into not only how Wall Street’s prime brokers enabled Archegos to build such heavily indebted positions, but also the banks’ collective approach to credit negotiation and risk management.

“If it is true that four big prime brokers, commercial banks, were sitting trying to negotiate a situation, what caused some of them to stand aside and act to reduce their exposure and let others sink?” said Berman, CEO of compliance consultancy CompliGlobe.

Berman and several experts told CNBC Tuesday that regulators should focus on risk reporting by regulated companies like investment banks.

Archegos has reportedly bought derivatives from banks known as total return swaps, which allow investors to bet on price movements without owning the underlying stocks. The fund was therefore able to use borrowing to build oversized positions that invest in global equity markets.

Banks released margin calls for the hedge fund last week – a request that Archegos add more money to its margin accounts or sell some of the assets held in them to bring it up to the minimum required by brokers. The hedge fund fell behind with these calls.

‘Ring fencing’ revised

“Regarding regulation, it’s not necessarily about regulating family businesses – I mean, if they want to bet their money, that’s fine – it’s the fact that it is leveraged,” said Thorsten Beck, professor of banking and banking Finance at Cass Business School.

“It is the fact that the various investment banks have borrowed too much money and are now trying to get all of their positions down in a rather uncoordinated manner. I think this is where regulation has to start.”

Beck told CNBC that some regulators may be considering “ring fencing” banking operations to ensure that such activities must be segregated from the commercial bank and entities that have an impact on the real economy when banks are potentially lending to want to forgive risky clients like Archegos.

Since January 2019, major banks in the UK have had to legally separate their private and investment banking activities to avoid shocks from the financial system that negatively impact consumer banking.

In contrast to the earlier US Glass-Steagall Act of 1933, which was repealed in 1999, the new UK legislation allows retail banks to be part of a larger banking group that also deals with investment banking.

Markets have largely shaken off the impact of Archegos as an isolated incident, as only a limited number of investment banks appear to be affected.

Luke Hickmore, investment director at Aberdeen Standard Investments, which holds Credit Suisse in its bond portfolio, said the likely success due to Monday’s stock movement “is unlikely to be enough to drain their capital buffers to the point where regulators step in.” “.

“The next shoe that falls”

However, Greg Williamson, Head of Strategy at Pluribus Labs, suggested that the issues highlighted by the Archegos collapse, which will come in the form of global regulatory changes, could have lasting effects.

“Things like total return swaps just weren’t examined for the positions held by the holders of the swaps. They really didn’t know what the risk was of the portfolio that went into the swap, but also of the bank that was on the other side of the swap, “Williamson told CNBC’s Squawk Box Europe on Tuesday.

“It is clear that neither party was in risk control when they entered into these total return swaps. I think the next shoe to fall will be an increase in regulatory oversight.”

Archegos founder and co-CEO Bill Hwang, who managed $ 10 billion in family money through the fund, previously worked at Tiger Management and pleaded guilty on behalf of his firm to an on behalf of the Securities and Exchange Commission In 2012, the case filed for insider trading.

“Most likely we will see derivatives added to an additional test and likely the pending derivatives positions added to the capital bases of banks and investment banks which could limit activity in the future. I think that’s the big shoe that could fall. “said Williamson.

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