Archegos ’catastrophe shows the hidden business risk of bank swaps
The Inadequate Archegos Capital it has exposed the opaque and hidden risks of the business of equity derivatives, which allow banks to hedge funds to make large bets on equities and related assets.
Bets placed Bill HwangThe family office has suffered heavy losses at Credit Suisse and Nomura, highlighting how these tools can trigger a chain reaction that is falling across financial markets.
Archegos was able to take in tens of trillions of dollars through swaps in ViacomCBS ’internal stock returns, a type of“ synthetic ”financing that is well-known in hedge funds that allows you to place very large bets without buying or disclosing shares. their positions.
It means companies like lack of transparency Archers it can make similar exchanges with various lenders that do not depend on the overall exposure of the investor if the positions are reversed by increasing the risk of hedging funds and banks.
Global banks generated approximately $ 11 billion in revenue from synthetic equity financing, including a total return swap in 2019, double the level of 2012, according to Finadium Consulting.
A business that has been growing rapidly since the financial crisis, Finadium estimates that banks account for more than half of their total capital financing income, which is traditional margin lending and equity lending. Synthetic financing has continued to take part in other forms of equity financing in the first half of this year.
Banks earn ongoing profits through returns on profits, while investors pay regular fees such as hedge funds to sign the agreement. The bank pays the investor if other assets, including shares or indices, increase in value. The bank also offers investors the dividends that come with holding shares.
The bank compensates for its exposure by owning the underlying shares by taking an opposite position with other clients with the opposite view or by buying hedging from another financial institution.
If stocks fall, the investor will have to pay a periodic margin, usually quarterly, to complete the bank.
“Since most swaps are carried out in large notional amounts. . . this could jeopardize the full repayment payer (usually the commercial or investment bank) of the hedge fund by default if the fund is not properly capitalized ”. According to Deloitte.
In particular, Archegos was in a situation when he aggravated several situations in his positions, leaving banks to sell hedges (shares) quickly. The situation became serious as Archegos entered into swap agreements with multiple banks.
Because they are tailor-made swaps in exchange for the full return on equity or are “prescriptions” between the two parties, they are not cleared and reported through an exchange. Investors also do not have to report their synthetic equity exposure to the U.S. Securities and Exchange Commission, as if they had the same amount of exposure through the intervention.
“We have a fundamental problem when it comes to reporting non-secret and non-new synthetic equity holdings,” said Tyler Gellasch, a former SEC official and executive director of the Healthy Markets advocacy group.
“If there are five different banks that offer financing to a single customer, each bank may not know it, and instead may think they can sell it to another bank if they have a problem – but they can’t, those banks already suffer.”
The growth of a full-return equity swap market “often developed as a good result by the Basel and Dodd-Frank rules [total return agreements] above the funding of monetary equity, ”said Josh Galper, CEO of Finadium, citing international and U.S. reforms following the financial crisis.
For banks, providing synthetic capital exposure is an attractive business because, when customer positions are combined with each other, margin requires less regulatory capital than traditional loans.
Galper said, “Capital ratios, liquidity ratios, and trade-reducing capabilities can be more advantageous than returns on returns” than other types of capital financing.
Exposing banks makes it difficult to measure exposure to foreign assets for measurement by outsiders.
“Even though large banks have derivative pages and outreach pages, they are usually at such a high level that you don’t come close to seeing information about individual counterparty / securities exposure,” said Dave Zion of the Zion Research Group. specialized accounting.
“Information on the concentration of credit risk is usually industry-wide and will be based on net receivables from creditors,” but when gross amounts may be cheaper when it comes to market risk, he said.
Some banks consider exchanges of full equity returns for accounting purposes as collateral loans, according to Nick Dunbar Risky Finance, a consultancy that specializes in bank appearances. The bank-derived trading desk does not reserve them and therefore does not appear in the Basel III files of the risk weighting assets, leverage and credit risks that all global banks must take.
Lack of information means that a full-fledged swap business, which is generally a source of constant returns for banks, hides rare but serious risks. A banker at the World Bank’s heritage-derived bank said it was “very difficult to know who it belongs to” and so exchanges of full-fledged returns are “a classic case of picking up nickel in the face of steam”.
“You can pick up those nickels all day. This steamroller moves pretty slowly. But if you make the trip, boy, do you run away? He said.