Archegos Indictment Raises New Questions About Banks’ Risk Management Controls | Investment News

By Elizabeth Dilts Marshall

NEW YORK (Reuters) – New details revealing how Archegos Capital Management founder Bill Hwang hid his fund’s extreme exposure from its lenders raise new questions about the risk management policies of these global banks, said former regulators and risk experts.

Hwang and Archegos chief financial officer Patrick Halligan were arrested on Wednesday for lying to banks to increase Archegos’ credit lines and using the money to increase their exposure to a handful of stocks, which they have also manipulated, according to a Justice Department complaint.

The couple vigorously deny all charges.

Archegos defaulted at the end of March 2021 after the value of its transactions fell and banks called on their credit lines, leaving global lenders including Credit Suisse AG, Nomura Holdings, Morgan Stanley and UBS Group AG with losses combined of about $10 billion.

While Justice Department portrays banks as victims who were lied to by Archegos executives, indictment reveals red flags banks could have acted on to reduce their exposure to aggressive banking transactions ‘Archegos, said risk experts.

These include the fund’s reluctance to provide certain details about its portfolio; his failure to provide evidence to support his claims; the huge spike in some shares held by Archegos; and the fund’s frequent non-compliance with its credit limits.

“There were a bunch of red flags that were missed by the banks,” said Julie Copeland, partner at consultancy StoneTurn. “But the banks don’t want to lose customers. That’s the tension.”

These failures could potentially see some banks rung by civil regulators, some experts have speculated.

Last week, a Justice Department official told reporters he could not say whether the banks faced further implications. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission, which also filed civil charges on Wednesday, declined to comment on Monday.

Credit Suisse, Nomura, Morgan Stanley and UBS declined to comment.

Archegos has built a highly concentrated exposure to a handful of stocks using bank-underwritten equity swaps. His positions were heavily leveraged, at times up to 1,000%, the SEC said.

Archegos traded through no less than nine banks. Because the fund had no regulatory requirement to report its overall exposures, number of lenders, or swap positions, each bank only had visibility into Archegos activity within its business.

Banks have frequently asked Archegos for more information on its trading positions held elsewhere to try to get a better picture of their exposure. Archegos, however, misled them about the liquidity, composition and concentration of its portfolio,

Yet in many cases, signed certifications or even the word of Archegos were good enough for banks, allowing them to obtain additional credit above the limits that banks had previously set, according to the deed of charge.

In February and March 2021, for example, UBS increased Archegos’ trading limits based in part on assurances from the fund that included false information about its concentration in certain stocks and its liquidity, according to the indictment. .

On March 24, 2021, Archegos asked an unnamed bank to wire it $248 million, the SEC said. When a bank executive asked why he needed the cash, Archegos said it was for portfolio rebalancing purposes and the fund had $9 billion on hand. With those assurances, the bank transferred the money to Archegos, the SEC said.

The Federal Reserve alluded to the failings in a December notice of the scandal in which it warned lenders against accepting “incomplete and unverified information” from funds and that such “practices represent due diligence.” insufficient”.

Archegos also declined to provide stock names or the precise size of its overall portfolio, the Justice Department said. That should have prompted executives to put more pressure on Archegos for information, or even demand an independent audit, risk experts said.

“If a counterparty fails to provide information, the bank must perform its own independent analysis,” said James Lam, president of risk consultancy James Lam & Associates. “If this verification cannot be performed, the risk limits and margin rules should not be changed.”

At one point, Archegos owned more than 30% of Discovery Inc’s daily volume and 50% of ViacomCBS’ free float, significantly altering their shareholding composition, according to the indictment.

The massive rise in price of these companies, despite no apparent fundamental reason, should have raised eyebrows, Copeland said.

These spikes, combined with Archegos’ rapidly growing capital and portfolio size, should have triggered a review of underlying risks and effective leverage, Lam said.

Alma Angotti, a partner at risk management consulting firm Guidehouse and a former SEC enforcement officer, said that even if banks have been lied to, regulators can still investigate whether their programs risk management systems have been poorly designed or implemented.

“Maybe they didn’t have the proper skepticism to say it doesn’t make sense.”

(Reporting by Elizabeth Dilts Marshall; editing by Michelle Price and Nick Zieminski)

Copyright 2022 Thomson Reuters.

James V. Hayes