By now, I assume that you have heard something of the situation involving Archegos, the family office of Bill Hwang, a former Tiger Cub. If not, the short version of the story is that this fund experienced significant margin liquidations over the past few sessions in order to meet its obligations to its prime brokers. As with other situations where excesses at one market participant spilled into markets as a whole, there are a wide range of current and future considerations that could affect investors across the financial spectrum.

This is one of the largest margin calls in history, so it certainly merits careful scrutiny. I think it is important to view the Archegos saga in two parts. First, what was specific to that fund and its holdings?Second, what if any second-order effects might result from the events around this fund? 

The most pressing question involving this fund is how a fund with a reported $5-$10 billion in capital end up with exposures that are likely to cause losses that may be as high as $30 billion?  A press release by Nomura indicates that it has about $2 billion from a US client, widely believed to Archegos. Credit Suisse (CS) declined to provide a number but noted a “highly significant and material” loss. Morgan Stanley (MS) and Goldman Sachs (GS) also warned of financial hits, though the latter described their loss as “immaterial.”Their situation is especially ironic, however, since they stopped doing business with Mr. Hwang after a guilty plea for wire fraud several years ago. 

It appears that the nexus of the saga relates to ViacomCBS (VIACA, VIAC). Consider the following graph:

VIACA Daily Chart, Past 3 Months

(Click on image to enlarge)

Source: Bloomberg

We can see that the stock began to go parabolic in February, after rising on a steady, but linear pace prior to that. The stock finally stalled around the $100 level. After the close last Monday, March 22^nd, the company announced that it would issue about $2.65 billion in equity and convertible bonds. The stock unsurprisingly fell about 10% the next day, but few would question the motives of a corporate board doing an equity financing after its shares doubled in about 5 weeks. The problems began to kick in when the stock fell to about $70 the next day. Remember, parabolic moves often comes to a messy end. Any investor who was utilizing margin would have experienced some stress after a two-day, 30% fall in a holding, but this was not an investor utilizing normal margin. It appears now that Archegos was more highly levered than that, and we don’t know if he was using his excess margin to continue buying VIAC or other holdings. Thus the quick drop in VIAC may have been the proverbial straw that broke the camel’s back.

The problem for those of us trying to decipher the situation is that most of the banks’ exposure to Archegos is via over-the-counter derivatives and swaps. The public has no way of knowing what the terms of those contracts may be, and can only guess about which stocks are truly affected and whether there may be residual exposures to those stocks that could move them substantially. Because the fund utilized non-exchange traded contracts, the shares were held in “street name” – the actual shares were held by the prime brokers as collateral for the contracts. This meant that Archegos was able to hide the extent of its equity holdings even before accounting for leverage. We have to wonder whether the prime brokers had sufficient clarity into the exposures that were faced by other market participants. Did Bank A have any knowledge that Archegos had even more levered exposure with Bank B?

This is how we need to look forward to the after-effects of this situation. Will there be regulatory moves to get customers or brokers to reveal the full extent of their holdings, rather than hiding behind opaque contracts? Will swaps and the like be subject to more position reporting on their own? Will banks be required to disclose reportable positions by holder rather than aggregating them in street name?

And most importantly for average investors, will there be a systemic de-leveraging by prime brokers upon their riskiest clients? It would be understandable if prime brokers were interested in paring back leverage that was extended to hedge fund clients and the like. The problem is, de-leveraging is a delicate process. Do it too quickly, and customers are forced to liquidate unexpectedly. Even if managed carefully, does the paring back of leverage provide a headwind for markets as a whole?

This has been a wild few days. The epic craziness may be largely behind us, but the after-effects may be lingering for quite some time.