Opaque world of trading

The investing world was shocked last week by block trades worth billions of dollars in highly visible shares —which, it emerged, was thanks to positions being swiftly closed by Wall Street in order to try and evade the fallout of the collapse of the Archegos Capital Management hedge fund. Archegos is the family office of Bill Hwang, who is forbidden by regulators in the US and Hong Kong from managing outside clients’ money. This was because he was accused of violating trading rules at his former hedge fund. Under most regulatory systems, family offices can be more lightly supervised, since they are essentially private wealth management vehicles of extremely wealthy individuals. Certainly, banks are not as undercapitalised now as they were in the run-up to the 2008 financial crisis. But the splash zone created by the sinking of Mr Hwang’s Archegos means regulators globally will have to ask some tough questions anyway.

The culture of Wall Street has not changed since 2008. Certainly, the widely expressed belief is that Mr Hwang was given a longer rope than he should have by lenders because he was also a lucrative brokerage client. The prime brokerage business, where banks lend hedge funds money and also process their trades, has always been controversial. Within these banks, the cowboy salesmen running this profitable business seem to ride roughshod over the sober credit risk analysis quants. Yet the more important question is whether regulation needs to be updated to rein in this behaviour. For one, even if it is those in family offices that are primarily taking on the risk associated with heavy leveraged bets, are banks risking publicly regulated deposits in underwriting these bets? Mr Hwang’s $10-billion fortune unravelled when he took a risky bet involving, among others, media major ViacomCBS, and eventually a cascade of margin calls set in. In the process, markets were disrupted and regulated entities like Credit Suisse and Nomura lost billions. Is there a significant systemic risk posed by unregulated family offices, given how large some of them have now grown? If not, why not? Regulators need a clear and transparent answer to these questions.

Archegos, like all family offices, escapes direct regulatory oversight. Since Mr Hwang was not marketing his fund to the public, current regulations did not require him to reveal strategies and performance indicators. But that wasn’t the only problem. In addition, it used financial derivatives called total return swaps to minimise its legal requirement to disclose stakes in listed companies. In this manner, it avoided filing the annual 13F report required for any investment manager holding US equities of more than $100 million. To the outside world, it looked like the shares in the companies that Mr Hwang was betting on were positions taken by banks like Goldman Sachs — when, in fact, Goldman and others had sold Mr Hwang swaps that they were hedging against. This appears to be a loophole that requires careful attention from regulators. Thus, even if family offices should be allowed to run risks, should there be greater transparency about the risks they are running, in order to ensure that anyone lending them money —including banks —has full information? It has now been reported that the US regulators received lengthy briefings on Monday from the Wall Street banks in question. Hopefully, the question that regulators are asking is whether regulation must update itself to manage this fresh risk.


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