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What happened with Archegos Capital Management?

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Financial institutions are constantly working on making ordinary people’s life more difficult, at the same time closing eyes on the illegal or high-risk activities/transactions from rich clients. Not so long ago, HSBC has been accused of moving tons of dirty money in both Mexico and Hong Kong. Some could think that this story would teach the banking sector to be more careful with the money they receive, but, as recent events show, the lesson has not been learned yet.

As a result, a couple of banks, including Nomura and Credit Suisse, lost billions of dollars. On top of that, their shares suffered some of the biggest one-day pullbacks. Of course, it won’t lead to bankruptcies but the fact remains – in pursuit of big money they forgot about risk management.

In the cash of Hwang’s Archegos Capital Management, banks allowed the family office to leverage its positions through swaps and so-called contracts-for-difference. Most probably, everyone knew what the consequences of something going wrong would be – margin call. Normally, there is no risk for a broker, but when the client pledges the shares as collateral from the investment banks/brokers from which it borrowed, things can easily get out of hand.

That is exactly what happened! When the value of the pledged shares fell, the broker requested additional shares from the client as collateral and when Archegos failed to invest, its broker dumped the shares that Archegos had pledged. The Swiss financial monster said it could suffer significant losses in the first quarter due to Archegos Capital Management’s default on margin requirements, which was the final blow to the Swiss lender.

 

What could happen next?

First, the collapse of Archegos could trigger a cascade of margin calls on other highly leveraged funds. This, in turn, can lead to a fall in the number of companies from completely different sectors. In other words, if the situation picks up turnover, it can lead to a drop of a technical nature, when shares will be sold only because a margin call comes. In principle, this can be a good signal for the “bags of money” to buy stocks on the cheap.

Second, we may see a tightening of leverage on the part of the major prime brokers, with the result that more funds are closing their positions to meet new margin requirements. This is bad for the stocks in which they buy long, but it could potentially be very attractive for the stocks they were short for.

 

Conclusion

What happened is a reminder of the continuing risk associated with huge rewards. In addition, it showed the imperfection of the financial system, when it follows transfers of 2000-3000 dollars, but turns a blind eye to billions of dollars in speculation. Finally, this is yet another reminder of the role that hedge funds play in the global capital markets and financial crisis.

 

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