Archegos Capital Exposes Skeletons in Wall Street’s Closet

Margin calls at the overly leveraged Archegos Capital Management – run by former Tiger Asia manager Bill Hwang – over the past week triggered the liquidation of stock positions approaching $30 billion in value.

So far, Credit Suisse, Goldman Sachs, Morgan Stanley, UBS and Nomura Securities have reported huge potential losses as a result of complex equity swaps – dubbed CFDs or contract for differences – with Archegos.

Apparently, Archegos built large stakes in companies such as ViacomCBS and Chinese Internet and search engine giant Baidu without actually owning most of the underlying securities through highly leveraged CFDs.

This is not the kind of buy and hold trading preached by responsible financial advisers for their Mom-and-Pop clients. This is the ugly reemergence of high-risk activity used by hedge funds and banks. Such strategies have a history of blowing up, with the fallout doing lots of damage to retirees’ portfolios.

Undoubtedly, the trades generated huge commissions and fees for Archegos’ trading partners but have left Wall Street firms holding the bag after significant margin calls were not met.

Hedge funds like Archegos and their bankers hide how they invest and make transactions, and this strategy obviously can cause harm to the wider investing public.

“While investors who build a stake of more than 5% in an U.S.-listed company usually have to disclose their position and future transactions, that’s not the case with stakes built through the type of derivatives apparently used by Archegos,” noted Blomberg earlier this week. “The products, which are made off exchanges, allow managers like Hwang to amass stakes in publicly traded companies without having to declare their holdings.”

Remember, this is just the latest chapter in the history of hedge funds causing great harm to specific firms. The Archegos meltdown will likely have a ripple effect throughout Wall Street and the economy.

Look no further than the $3.6 billion bailout of Long-Term Capital Management by Wall Street banks who had substantial exposure to the firm over two decades ago.  In 2007, the implosion of two Bear Stearns hedge funds blew up and many have pointed to that multi-billion-dollar loss as the start of the 2008 financial crisis.

Most recently, hedge fund Melvin Capital suffered billions in losses as a result of being short – or betting the price of share would drop – on Game Stop as the stock dramatically rose due to small investors pushing the stock upward.

And let’s not forget Greensill Capital.  Greensill, a simple supply chain finance company went belly up after deciding to securitize supplier invoices.

Sounds like hedge fund debacles are back. And this raises plenty of issues for the new Biden administration. One obvious question that needs to be asked is whether regulators are doing enough to control outsized risks by hedge funds and Wall Street banks.

We hope that banks and their compliance departments have learned that chasing huge complex transactions with shaky borrowers is not worth the risk to their capital base and shareholders. The lure of fees and commissions from hedge funds like Archegos, and the bonuses bankers reel in for generating such sales, remains significant cause for concern.

“The idea that one firm can quietly amass outsized positions through the use of derivatives could set off another wave of criticism directed against loosely regulated firms that have the power to destabilize markets,” Bloomberg reported.

In the wake of the Archegos’ collapse, we need to ask whether there are other skeletons that are lurking on the balance sheets of Wall Street firms. If one hedge fund was using CFDs, it’s safe to bet plenty of others are, too.