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Archegos imploded and wiped billions off the market, turning the spotlight on the virtually unregulated family office sector industry. Experts spell out how the damage was done.

Published by Business Insider on Thu, 01 Apr 2021

<p><img src="https://static4.businessinsider.com/image/6065e3ea902281001950a913-1438/Screen Shot 2021-03-30 at 122706 PM.png" border="0" alt="Bill Hwang" data-mce-source="YouTube" data-link="https://www.youtube.com/watch'v=vnbeQ-WFOUU"></p><p></p><bi-shortcode id="summary-shortcode" data-type="summary-shortcode" class="mceNonEditable" contenteditable="false">Summary List Placement</bi-shortcode><ul class="summary-list"><li>The dramatic implosion of Archegos Capital Management has turned the spotlight on family offices.</li><li>These usually conservative financial institutions are effectively unregulated, but that can be risky.</li><li>Archegos blew an estimated $10 billion hole in some banks, using leverage and derivatives.</li><li id="recirc"><a href="https://newsletter.businessinsider.com/join/4np/10-things-opening-bell'utm_source=markets&amp;utm_medium=ingest'utm_source=markets&amp;utm_medium=ingest'utm_source=markets&amp;utm_medium=ingest'utm_source=markets&amp;utm_medium=ingest" target="_blank" rel="noopener">Sign up here for our daily newsletter, 10 Things Before the Opening Bell</a>.</li></ul><p>Family offices sound innocent, but one just blew an estimated $10 billion hole in some of the world's biggest banks.</p><p>Bill Hwang's Archegos Capital Management was a large investment firm funding risky bets through lots of borrowing. But it was structured as a "family office", a type of financial institution designed to preserve and grow a rich person's wealth, meaning it went largely unnoticed.</p><p>It shot to prominence this week, however, after it emerged that its bankers had confiscated its holdings and sold them in huge chunks, <a href="https://www.businessinsider.com/archegos-hedge-fund-liquidation-wall-street-credit-suisse-nomura-goldman-2021-3">wiping around $35 billion</a> off US media group <a href="https://markets.businessinsider.com/stocks/viac-stock">ViacomCBS</a> and certain Chinese tech stocks on Friday. JPMorgan <a href="https://www.businessinsider.com/archegos-banks-10-billion-losses-liquidation-jpmorgan-nomura-credit-suisse-2021-3">has estimated</a>&nbsp;the affair could end up costing Nomura, Credit Suisse and others $10 billion.</p><p>So how did a largely unheard-of investment fund end up causing so much damage'</p><p><strong>Family offices can be virtually unregulated</strong></p><p>A key part of the story is that Archegos was a family office, set up to manage the wealth of Bill Hwang, a former hedge fund executive who <a href="https://markets.businessinsider.com/news/stocks/who-is-bill-hwang-archegos-tiger-cub-christian-insider-trading-2021-3-1030255723">pleaded guilty to insider trading</a> in 2012.</p><p>Family offices are investment entities that manage the wealth of the rich, and are traditionally pretty conservative institutions.</p><p>People setting up family offices are most often "focused on preserving the core values that led to their wealth creation, protecting their children and future generations," William Bijesse, a family office expert at audit and tax firm RSM, told Insider. "Not on leveraged bets that could multiply their net worth."</p><p>This focus means family offices are usually exempt from direct regulation by the Securities and Exchange Commission. One financial regulation expert told Insider: "The basic philosophy of regulators with respect to family offices is: what you do with your own money is your own business."</p><p>Family offices can be very large, however. George Soros' Soros Fund Management is structured as a family office, for example, while Bill Gates, Jeff Bezos, and the Walton family have offices with tens of billions of dollars under their control.</p><p><strong>Leverage and financial derivatives spurred Archegos' fall</strong></p><p>Archegos went further than most family offices, however, and added two dangerous ingredients to the mix: large amounts of leverage and risky financial derivatives.</p><p>The light regulation of family offices means there are almost no rules about leverage - that is, borrowing to fund investments - which apply to some other sectors, such as mutual funds.</p><p>Hwang's fund appears to have borrowed heavily from banks including Goldman Sachs, Morgan Stanley and Credit Suisse to make <a href="https://www.businessinsider.com/archegos-capital-margin-call-20-billion-liquidation-8-stocks-plummeted-2021-3">big bets on stocks like ViacomCBS</a>. To place these bets, it used opaque financial products such as total return swaps, according to reports.</p><p>These financial products allow investors to gain exposure to companies without actually having to own stock in the firms, in exchange for a fee. Crucially, they mean the investor does not have to disclose any positions in companies to regulators under SEC rules.</p><p>Gerard Cassidy, US bank analyst at RBC Capital Markets, told Insider the Archegos affair raised questions about leverage and reporting.</p><p>"Should there be some more structured reporting [for] the large hedge funds and others that use very meaningful amounts of leverage'" he said.</p><p>"That's the key here. Leverage is always a two-edged sword. In a bull market when prices are rising it enhances your returns. And then in a falling market, like you just saw in this particular case, it cuts your head off."</p><p>Archegos' problems arose when its banks demanded it stump up more cash to cover its positions in stocks like ViacomCBS, which were falling. It couldn't do so, leading to a so-called forced deleveraging.</p><p><strong>Banks took big risks, but appear stable</strong></p><p>On the other side of the equation were the banks lending large amounts to Hwang's family office and providing access to derivatives. Such prime brokerage services can be extremely lucrative but very risky.</p><p>Analysts at JPMorgan, led by Kian Abouhossein, said in a note "the use of equity-swaps increased the inability of [the banks] to see the concentration risk in holdings within the hedge fund in question, in our view." They also said they suspected there was "poor risk" management at Nomura and Credit Suisse in particular.</p><p>Yet Cassidy said that, although questions could be asked about the regulation of family offices, the post-2008 banking reforms proved effective.</p><p>&nbsp;"Since the financial crisis the big banks have all been required to carry more liquidity, they've been required to carry more capital." He said the Archegos affair could have been a "contagion" scenario if it happened before the new rules came into force. "The system worked," he said.</p><p>Archegos was unavailable for comment but spokesperson Karen Kessler told Reuters: "This is a challenging time for the family office of Archegos Capital Management, our partners and employees."</p><p>"All plans are being discussed as Mr. Hwang and the team determine the best path forward," she said.</p><p><a href="https://www.businessinsider.com/archegos-liquidation-spotlight-unregulated-family-offices-leverage-swaps-2021-4#comments">Join the conversation about this story &#187;</a></p> <p>NOW WATCH: <a href="https://www.businessinsider.com/electric-planes-future-of-aviation-problems-regulations-2020-3">Why electric planes haven't taken off yet</a></p>
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