Archegos’s cautionary tale for banking

In ancient Greek, Archegos is a leader or pioneer. The eponymous family office certainly pioneered financial acrobatics. Forced to liquidate positions in blue-chip stocks after being unable to pay margin calls, Archegos Capital left some of the world’s biggest banks with outsize losses, and regulators with some questions to answer.

Credit Suisse and Nomura look to be the hardest hit by Archegos, run by Bill Hwang, a buccaneering American financier whose former hedge fund was charged with insider trading. Credit Suisse could lose $4bn from the affair, more than its net profit last year.

As with many financial cautionary tales, the Archegos parable turns on leverage. Hwang was able to build up huge positions through total return swaps. These derivatives allow investors to take a position in a stock while the underlying security is owned by the bank. Banks like them as they can carry lighter capital requirements. They permit investors to amass far larger positions than they would otherwise have to disclose, which allowed Hwang to quietly amplify his profit — but also his losses. As a family office, Archegos was exempt from disclosure obligations required from hedge funds. That loophole needs tightening.

Banks have questions to answer. In a low-interest environment, they were hungry for returns, while fat fees blinded them to dubious decisions — such as the wisdom of extending credit to an entity whose founder was fined over insider-trading. Risk management at Credit Suisse in particular should be scrutinised, with this coming so soon after blow-ups with Greensill Capital, Wirecard and the so-called tuna bond farrago. Common to all episodes is an ineffective risk-warning system too easily overruled by deal-hungry senior managers. 

The banks are examining whether Archegos was fully transparent about the size of its positions with rival prime brokers — a combined $50bn at the latest estimates. The courts, and even regulators, should adjudicate if that was not the case. 

That the banks can nurse such losses but raise no questions about their solvency is a vindication of tougher capital requirements introduced since the financial crisis. But there are worrying lessons from 2008 — weak risk controls and highly leveraged positions — that banks simply have not heeded. If Archegos is an isolated incident this may not matter but the concern is if wider patterns emerge.

The financial landscape has also shifted since the crisis. Banks were the dominant force for centuries but that is changing. Equally important now is non-bank financial intermediation, better known as shadow banking. The umbrella term covers everything from a pension fund to Archegos. Banks and their shadow counterparts are interlinked, however, and problems in one can spill over to the other, and to the real economy. 

Some steps were taken globally to tame the most toxic parts of non-bank finance. Dealing with disparate entities in different jurisdictions means finding common rules is hard. Reforms can target regulated banks that act as prime brokers to leveraged counterparties. Margin requirements — banks’ demands for counterparties to put up more collateral for trades; the catalyst for Archegos’s woes — could be made more countercyclical. When asset prices rise, so too should the margin required to initiate trades. That would protect banks more in times of stress.

Financial-reform fatigue has set in and banks are forgetting the fundamental lessons of the crisis. Archegos’s parable is a warning they must not repeat the same mistakes.