The week of March 26 showed rarely seen explosive volatility in Chinese stock and commodities as Archegos Capital Management, a self-described family investment office, materialized billions of dollars in losses as Wall Street investment banks such as Goldman Sachs liquidated its positions in a little known, lightly regulated area known as total return swaps.
A total return swap is a type of derivative investment instrument. In a conventional trade an individual, a bank, or a fund may buy a share of a company for say, $100, and then hold that share in their portfolio. If the stock goes up they can sell and reap the profit. If the stock goes down they can hold the stock as an asset and try to wait for the price to go back up.
In a total return swap, a party, such as Archegos, is effectively betting on the short term rise or fall of a company’s price without owning the underlying stock. The trade is backed by collateral posted, whether cash or stock. An investment bank such as Goldman Sachs facilitates the trade by buying a “basket” of the stocks being traded, as it underwrites the risk of the swap bet, in a sum smaller than the total position, and collects a fee in the process.
If the trade goes against the investor and the market value of the position begins to approach or exceed the size of the collateral posted, it works like a loan where the position can be closed (defaulted on) in a “margin call,” leading to a forced liquidation of the position as the investment bank seeks to cover the contract. Whatever losses remain to be paid after liquidation are owed as a debt.
According to Wall Street Journal, “Archegos is estimated to have managed about $10 billion of its own money, according to people familiar with the fund. Its total positions that were unwound approached $30 billion thanks to leverage Archegos obtained from banks.”
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WSJ says the use of swaps provided Archegos with two advantages. The first, leverage (a loan) to trade $30 billion worth of positions with only a fraction as collateral, and the second, anonymity, as investors who own more than 10 percent of a company’s shares are required to disclose their positions with the SEC in public Form 13F filings. Trading swap contracts does not trigger the SEC’s disclosure requirement.
The week of March 26 saw shares in Viacom, which was one of several Archegos’s holdings, fall spectacularly from an opening price of $99.15 to a low of $39.81. Viacom reached a new all-time high this month at $101.97, exceeding its previous of $70.10 set in April 2017. The institutional buying of these stocks to underwrite Archegos’ enormous swap trades may have been a key factor that drove the new high.
According to a March 28 WSJ article, the massive volatility in Viacom and Discovery resulted from Archegos, which was formerly Tiger Asia and is managed by Bill Hwang, defaulting on its position with banks such as Goldman, Morgan Stanley, Deutsche Bank AG, and UBS Group, leading to the banks dumping the underlying assets they purchased to facilitate Hwang’s positions.
Earlier in the week, the collapse of a $3 billion Viacom stock offering through JPMorgan and Morgan Stanley fell apart. The collapse appeared to be one of the catalysts which drove Archegos’s positions into the red, according to CNBC.
Chinese stock faces US regulatory pressure
Friday saw a sharp sell-off in Chinese stocks such as GSX Tutoring and Tencent Music, which saw a 57 percent and 36 percent weekly loss respectively as a new SEC rule will require foreign companies to disclose government affiliations and influence. The rules will apply to all companies, but provide specific issues to Chinese companies as they will have to expose their connection to the Chinese Communist Party (CCP).
While CNBC says Chinese companies have to disclose board members who are CCP officials, the caveat to the new Holding Foreign Companies Accountable Act regulations is the companies have three years to comply before being delisted by U.S. regulators.
WSJ said the stocks the investment banks held as collateral on Archegos’ swap positions ended up providing liquidity to their own clients, “Goldman Sachs told some hedge funds on Friday that they were selling large blocks of stocks as a result of the involuntary deleveraging of a fund.”
“The bank’s traders said they would give priority to customers who could buy as much stock as possible or several blocks of stock in different companies. Morgan Stanley similarly marketed a block of stocks in multiple companies Friday, saying buyers couldn’t bid on individual companies in the basket, said investors.”
The Journal reported Goldman dumped $1.8 billion worth of Tencent Music while Morgan Stanley sold off $600 million on Friday alone.
Archegos Capital Management’s 2008 crisis connection
In 2012, Sungkook (Bill) Hwang and Tiger Asia Management LLC pleaded guilty to a criminal fraud charge and forfeited $16 million in penalties and $44 million to settle a civil lawsuit after Hwang and Tiger Asia short sold Chinese bank stocks and bought them back on the cheap after obtaining confidential information about private placement funding rounds in the same banks.
The website for Archegos Capital Management has since gone offline. However, a capture of the site on Archive.org shows the firm’s long-standing ties to Wall Street. On their management page, Co-President Brian Jones was formerly Senior Managing Director at Bear Sterns, Co-President Diana Pae, whose LinkedIn profile no longer exists, was formerly a Managing Director at Goldman Sachs with experience at JPMorgan, CTO, and Head of Quantitative Research Jensen Ko worked for Volaris Advisors, which was acquired by Credit Suisse, as well as Goldman.
Chief Compliance Officer Michael Satine was a VP and Executive Director of compliance programs at Goldman Sachs, and perhaps most notably, William Tomita, Archegos’s Head Trader, was a trader at the notorious Lehman Brothers of 2008 housing bubble fame.
“This is a challenging time for the family office of Archegos Capital Management, our partners and employees. All plans are being discussed as Mr. Hwang and the team determine the best path forward,” read a statement by an Archegos spokesperson, said Market Watch, who also speculates that Hwang’s total position size in his firm’s trades may have been closer to $100 billion.