From seemingly out of the blue, Archegos Capital became the most talked about investor in the world last week. And it was not for a good reason.
According to reports, Archegos Capital, the New York-based family office of Bill Hwang, accumulated large, concentrated positions in certain stocks through total return swaps. When those stocks began to drop in price, the decreasing values required additional collateral to be provided to the prime brokers to maintain the positions. Archegos Capital did not have enough liquid assets to cover the margin calls, and the counter parties began to sell off large blocks of the names in an attempt to mitigate their risk and reduce their exposure. As more of Archegos Capital’s counterparties entered the market attempting to reduce their exposure, the sell off further exacerbated the falling prices of the stocks. Other investors uninvolved began to see losses and started selling into the mania to protect themselves.
When all was said and done, it is estimated that Archegos Capital’s counterparties suffered billions of dollars in losses, while Archegos Capital itself saw $8 billion disappear. The stocks that were the subject of the trading saw millions of dollars in losses of market value.
This story is a familiar one.
What happened last week is the boogey man of every trader, broker, bank and regulator. What makes this particular situation so incredible, is that it is exactly the type of activity that the Wall Street Reform Act of 2010 was meant to address and prevent, and the same types of activities that lead to the credit market meltdown in 2007. So, how could this happen?
For years, Bill Hwang symbolized the success of Tiger Management Founder Julian Robertson’s “Tiger Cubs” strategy where Robertson would seed mostly young, unproven but smart hedge fund managers, which later blossomed into hedge fund titans. At his zenith in 2007, Hwang’s hedge fund firm Tiger Asia had more than $8 billion in management and reportedly generated an annual return in excess of 40%. In 2012, an SEC investigation ended with Hwang entering into a settlement which prohibited him from managing money for clients. He was not, however, prohibited from managing his own money. Hwang returned all outside capital and converted Tiger Asia into a family office: Archegos Capital.
Family offices that exclusively manage one fortune are generally exempt from registering as investment advisers with the SEC. As a result of not having to register, family offices can avoid compliance program requirements and SEC oversight applicable to registered investment advisers, including SEC examinations and, perhaps very importantly in this situation, certain regulatory filings, like Form PF, which are designed to identify areas of systemic risk in the financial system.
Another contributing factor was the nature of the instruments themselves. Total return swaps are agreements with prime brokers that allowed Archegos Capital to take on the profits and losses of a portfolio of stocks without actually owning those stocks. Therefore, Archegos was not obligated to file Section 13 shareholder filings required for large equity positions. Instead, because the reporting requirements for the underlying equity positions falls to the prime brokers that are the counterparties in the transactions, it is not possible to identify the investments as being associated with any specific investor. This anonymity may have been even more attractive in the past few months as the public reporting of positions has made some institutional managers susceptible to coordinated attacks by retail investors, as demonstrated earlier this year with respect to GameStop. However, in addition to cloaking the firm from adverse actions by other investors and market participants, it may also have cloaked the level of risk to which Archegos Capital was exposed from its counterparties and regulators.
Compliance Considerations for Family Offices
At present, regulators in the U.S., Japan, Britain and Switzerland are known to be investigating the fall out of the Archegos Capital trades. With the large losses suffered by the parties involved, the market turmoil created by the trading, and the global reach, it is unlikely that the full impact of the situation will emerge anytime soon. However, family offices, and others relying on exemptions from registration under the Advisers Act should expect to see an increased level of scrutiny, and likely a renewed discussion surrounding the appropriateness of continuing to exempt such firms from regulation.
Unregistered firms, exempt firms and family offices may also wish to revisit their compliance programs and risk management policies and procedures to ensure that they have adequately addressed their regulatory risks. Many firms, while not required to be registered, have adopted compliance programs in line with the Advisers Act requirements as part of their risk management posture, and in an effort to avoid similar situations.
If you would like to discuss your firm’s compliance program and risk management efforts in light of the Archegos Capital situation, please contact your Greyline consultant or J.P. Gonzalez at (425) 223-1538 or jp@greyline.co.
