Risk Mismanagement
Since closing at an all-time high share price of $100.28 on March 22nd, 2021, shares of Viacom CBS (VIACA) ripped down to an intraday low of $40.78 on March 26th. Similarly, after reaching a 52-week high of $78.14 on March 19th, Discovery (DISCA) shares shaved off nearly 27%, reaching an intraday low of $41.90 on March 26th. Chinese-domiciled companies trading in the US markets such as Baidu (BIDU) and Tencent (TME) wiped off 33.5% and 48.5% on March 26th, respectively. With the unusual share price action in otherwise strong corporations in a recently smooth-sailing capital market environment, reports quickly swirled. Most of the discussion linked to large amounts of block trades placed on each of the aforementioned equities by Archegos Capital Management, a former hedge-fund turned family office run by Bill Hwang. (#1Davies et al., 2021). Initially, the propensity and velocity in the price moves of the stocks were alarming. However, $10 Billion total in losses, the wiping out of a global investment banks risk division, and an ultimate mismanagement of risk are the most alarming aspects in the Archegos Capital Management scandal. This has led the shareholders of banks involved to question why the trades blew up, and how to ensure a situation like this does not unfold in the future.
Given the commencement of bank earnings on April 14th, the major involvements of UBS Group AG, Nomura Holdings, Inc., Credit Suisse Group AG, and Morgan Stanley within the Archegos scandal have been revealed. Along with the financial strain, damage to the reputation of risk management on Wall Street has detrimentally affected the banks. Particularly, Credit Suisse lost $5.5 billion, Nomura Holdings: $2.85 billion, Morgan Stanley: $911 million, UBS Group: $861 million and Mitsubishi UFJ Group stomached a $300 million loss. Credit Suisse, being the biggest loser within the case, has been prompted to revamp the leadership within their investment banking and risk management divisions. Chief risk and compliance officer Lara Warner and investment bank head Brian Chin have been among the most notable employees to face repercussions. Furthermore, Credit Suisse involvement has led to a $900 million net loss for the first quarter of 2020 and a near 60% cut to their dividend. Given the large amount of losses across some of the most reputable financial institutions on Wall Street, some investors are left wondering, “How was Bill Hwang able to amass so much capital to invest in such highly concentrated positions?”.
Bill Hwang took out large loans through prime brokerage divisions at each of the aforementioned investment banks. Prime brokerage divisions at financial institutions can be described as a bundle of services exclusively offered to hedge funds and large institutional investors. Prime brokerage services are a way for large investors to borrow cash or financial securities, access research, and spread out risk exposure when investing. Notably, in traditional retail investing (i.e: Robinhood) an investor is only able to access a leverage ratio of 2:1. Through use of a prime brokerage, hedge funds are able to take much larger positions through sophisticated financial instruments, and use leverage ratio’s upwards of 5 to 1. When financial institutions offer their services in prime brokerage, they have now allowed skin in the game with hopes of making money off their sophisticated investors' decisions. Typically, banks also have no problem with taking this risk on hedge funds and large institutional investors as it is expected that the capital be used diligently in a largely diversified and uncorrelated portfolio of investments.
By using the prime brokerage units in the respective banks, Bill Hwang was able to amass a large amount of financial leverage in a large number of highly correlated positions within the technology sector. In the example of Archegos Capital Management, Bill Hwang individually developed a relationship with the prime brokerage divisions of UBS Group AG, Nomura Holdings, Inc., Credit Suisse Group AG, Morgan Stanley, Goldman Sachs, and Mitsubishi UFJ Group. Through the leverage extracted from the aforementioned banks, Bill Hwang was able to create a highly correlated portfolio of tech and media stocks as well as engaging in a financial instrument known as a “swap” in order to hedge his risk.
The unraveling of the trades occurred during the week of March 22nd, when Viacom CBS announced a $3 billion sale of stock and convertible debt. The company’s shares rising three fold in the past four months was interpreted internally by CBS as a result of the company’s strong operating performance. In a strong equity position, a company will regularly take advantage of a flourishing capital market position with the intent to grow by raising funds for the business. In Viacom CBS’s case, capital was being raised for investment into the rapidly growing streaming industry as they have been quickly losing market share to companies like Apple TV, DIsney +, Netflix, etc. The reasoning for the capital appreciation in the share price was due to Archegos Capital Management’s massive buying in the stock, when a $3 billion dollar offering hit the public market and Archegos did not buy, this caused the stock to crater. Subsequently, as the share prices began to lose value rapidly, prime brokers of Archegos quickly set off large block trades, sending the share price falling further before settling at a low of $41.90 on March 26th.
Investors raise the question of Bill Hwang’s integrity, transparency in trading, and the shortcoming of these financial institutions in being able to spot their highly risky exposures before it is too late. First, it came to be known that Bill Hwang was previously convicted of insider trading in 2012 while working with Tiger Global Management hedge fund. Regardless of his history, the prime brokerage divisions were clearly not worried about the traders actions or riskiness. Further, the transparency in trading was practically nonexistent. The financial institutions lending to Bill Hwang knew of some of his positions, but not all. These financial institutions also knew that Bill Hwang was levered, but not how much. The lack of diligence within these financial institutions has left a gray area, which has further led to detrimental losses as a result. Lastly, the risk tools in place at financial institutions are among the fastest, intuitive, and rapidly changing tools in the capital markets. For example, risk measurements known as RiskMetrics by J.P. Morgan and UBS Delta by UBS group are internally built portfolio analysis and risk management systems in which managers are able to optimize performance. Within these systems, a component which none of them encapsulates is the complete visibility of their clients true risk exposure. Financial institutions are left reaching for their pockets due to lack of due diligence of clientele. This is a problem that was exposed within the Archegos Management scandal and exploited by investors.This experience has been exposing and reputational diminishing. The large financial institutions involved in this debacle not only have a long way back financially, but a large responsibility to make sure the same mistake does not happen twice.
Works Cited
https://www.reuters.com/article/us-usa-markets-blocktrades-fallout-analy-idUSKBN2BM0CG
https://www.marketplace.org/2019/06/19/a-history-of-the-feds-interest-rate-hikes
https://www.sec.gov/news/press-release/2012-2012-264htm
https://www.wsj.com/articles/ubs-takes-surprise-774-million-archegos-hit-11619501547
