Regulators Grill Banks About Archegos Blowup As Market Ponders Broader Risks

Traders across Wall Street and on the buy side are anxiously waiting to see if any more big block trades in names like VIAC, GXU, TME and the other constituents of Archegos founder Bill Hwang's busted portfolio will wander across the tape. As journalists, regulators and academics question how Hwang was ever allowed to take on so much leverage (a question that has yet to be thoroughly answered), Bloomberg reports that regulators have already started asking prime brokers tough questions about how this was allowed to happen.

Bloomberg reported that the prime brokers spent Monday briefing US regulators as Washington starts to dig in into a historic fund blowup that could have broader implications for market stability. According to the report, the SEC hastily summoned banks for meetings on what triggered the forced sale, while Finra, the industry self-regulator, asked brokerages about the impact to their operations and credit risks, people familiar said.

"We have been monitoring the situation and communicating with market participants since last week," an SEC spokesperson said in emailed statement. A Finra spokesman declined to comment.

But that's not all the Achegos news we're seeing Tuesday morning. Mitsubishi Financial Group has just become the latest major bank to warn about losses tied to the Archegos blowup, reporting that $300MM might be at risk. Of course, that's a paltry sum compared to the potential $2 billion claim reported by Nomura, Bloomberg.

MUFG's securities arm said in a statement on Tuesday that it is evaluating the extent of the loss at its European subsidiary, which may change depending on market prices and the unwinding of transactions.

Mitsubishi UFJ Securities Holdings Co. said any loss won't have a material impact on the firm's business capability or financial soundness. A representative for the firm declined to comment beyond what it said in the statement.

Mitsubishi wasn't among the prime brokers who met last week to try and manage the unwind of Archegos's positions in a way that wouldn't saddle them all with huge losses – though Goldman and MS's decisions to break ranks with a series of block trades helped trigger the fire sale. And it's possible that more banks could come forward with losses.

Bill Hwang

As more details about the blow-up have emerged over the past 24 hours, academics like Boston University finance lecturer Mark Williams have been quoted in the press criticizing apparent shortcomings in banks' risk-management. "In this environment, where information flows quickly and you have to move quickly, this demonstrates a significant weakness on the part of Nomura's risk management," Williams said. "Did they not understand the risks they entered into, or did they ignore them because they wanted to grow?"

Put another way: Did Archegos mislead its prime brokers about its total leverage and exposure? Or did the intense competition among PB desks incentivize them to simply ignore these risks (perhaps figuring that, if Hwang's positions went tits up, competitors would be incentivize to cooperate and work out out a solution)?

What's more, Larry Peruzzi, director of international trading at Mischler Financial says the Archegos Capital block-trade incident could lead to calls for new regulations such as limiting the size of blocks or prohibiting off-board discounted prints on the open and close, or during the first or last 30 minutes of trading. It "will be tough, though, as exchanges and investors like liquidity," Peruzzi said in a statement reportedly emailed to Bloomberg. "These types of swings seem to be another factor in pushing more trading into passive strategies".

At any rate, Fed Chairman Jerome Powell has repeatedly touted the resilience of post-GFC banking regs. "We actually monitor financial conditions very, very broadly and carefully. And we didn't do that before the global financial crisis 12 years ago. Now we do," Powell said during the post-FOMC Q&A on March 17. Unfortunately for him, the biggest hedge fund blowup since LCTM has revived talk about the risks of "leverage gone wrong," as Bloomberg pointed out in a piece published last night,

Sameer Samana, Wells Fargo Investment Institute's senior global market strategist, added that "[w]hat it does make me think of is how much leverage in aggregate has now built up in the system" in brokerage accounts, options and credit, Samana said. "If a broader stock market pullback were to take shape, especially in the more widely owned areas of technology and technology-related stocks, a much bigger unwind would have to take place."

But as Bloomberg's Brian Chappatta pointed out (and as we have mentioned several times), Archegos' use of CFDs, an opaque derivative reserved for institutional clients, allowed his firm to crank up its exposure to ViacomCBS and the other companies without needing to file ownership disclosures. The shares themselves remained securely with the banks. This arrangement, Chappatta continued, could represent "a blind spot" for regulators, and raising the prospect that the market could see more hedge fund or "family office" blowups in the near future, should equities face further broad-based selling pressure.

"The world has already been battling a once-in-a-century pandemic," Chappatta wrote. "The last thing it needs is big banks heaping on risk in search of profits, leaving someone else to hold the bag." That's well put.

While AOC and her fellow progressive Democrats haven't publicly called for a hearing, at least not yet, we imagine the big banks will swiftly turn on their client, placing the blame for what happened squarely with Achegos. Though JPM managed to escape the drama, one twitter wit captured this point with a meme.