These events, however, should not be played down as ‘stress tests’, as that is not what they were at all. They were a form of people’s revolution, and that is why the institutional and interbank dealing sector is now outing itself in the media using heroic terminology and considering itself the means by which every trader and market participant in the world is still on an even keel.
This must be taken with a very large barrel of salt.
Let’s look at all of these events individually and dissect why there has been no evolution for the institutional prime brokerage or hedge fund sector, and why the road ahead is in the hands of innovative retail electronic trading firms with good quality in-house trading infrastructure.
The Demise of the Archegos Hedge Fund
Here is a clear example of the ability of those with a silver tongue to be able to convince large institutions to give them trade clearing relationships and large margin accounts.
Archegos Capital Management was founded in 2013 by Bill Hwang, who was hailed at the time as a ‘superstar’, which is a relatively new and somewhat odd term for a financial industry professional. Back in the early 1990s at the beginning of my career, this type of terminology was reserved for performing artists, whereas good traders were known as, well, good traders.
The contradiction here, however, is that Mr Hwang was not really a ‘superstar’, but an erudite and confident man who was able to convince people that he was.
In fact, he had already had a serious brush with the regulators in the United States at an early stage in his career when he was headhunted by Tiger Asia Management by one of his clients.
Mr Hwang’s journey began when he left his first job in the industry which was at Hyundai Securities in New York, and went to work for Peregrine Financial Group (PFG) which is now famously defunct, itself having been the center of a scandal at the beginning of the last decade, its demise along with MF Global’s equally catastrophic end, being used as one of the main reasons for the Dodd-Frank Wall Street Reform Act having been signed into US law by former president Barack Obama.
Whilst he was working at PFG, one of his customers was Julian Robertson who owned Tiger Management and was subsequently offered a job there.
Shortly afterwards, that hedge fund was closed down, however Mr Robertson gave Mr Hwang around $25 million to launch his own fund, which was given a similar name, Tiger Asia Management, which grew to over $5 billion at its peak.
Tiger Asia Management suffered extreme losses during the recession at the end of the 2000s and in 2012, Tiger Asia Management and Mr Hwang paid a $44 million settlement to the U.S. Securities and Exchange Commission in relation to insider trading, and as if insider trading and a conviction for it was not bad enough, just two years later, Mr Hwang was banned from trading in Hong Kong for four years.
A total blind eye was turned to this, and he was allowed to begin his Archegos Capital Management venture, with some major Tier 1 banks on side in 2012 immediately after he closed down the ill-fated Tiger Asia Management.
So, a pattern is now clear. Mr Hwang’s own ventures had been a pattern of disaster before he began his Archegos venture.
The facts are that by the end of the first quarter of 2021, the losses at Archegos Capital Management caused the default and liquidation of positions approaching $30 billion in value, leading to substantial losses to Nomura and Credit Suisse, as well as Goldman Sachs and Morgan Stanley.
Large positions were open in stocks in North American and Chinese corporate giants at the time. Due to the default, Cedit Suisse exited its prime brokerage business as a result of losing $5.5 billion. Archegos had a 20% share of Texas Capital Bancshares, the firm’s stake having increased by 93% then plummeted severely after Archego’s collapse.
Nobody can possibly say that any of this is an example of good risk management or risk assessment by prime brokerage divisions of Tier 1 banks.
Quite the opposite view would be more appropriate.
Therefore, for prime brokerage commentators to say that this meltdown which caused Nomura and Credit Suisse, two of the largest FX interbank prime brokers by market share in the world, to scale back their prime brokerage offering, is anything other than a monstrous risk management disaster and failure to understand the basic concept of counterparty credit assessment, and certainly is not a good thing which has raised new questions about how effective prime brokerage risk management needs to be.
In fact, this is another good reason why non-bank market makers and OTC derivatives firms with their own dealing desk and good practices are now shining out as an example. It is because of this legacy of allowing multi-million dollar crashes and then picking off trades sent by their own clients by using last look execution procedures or requotes/rejections that alienation has occurred and the retail OTC industry has looked elsewhere and is either concentrating on warehousing trades, known as a b-book model, or passing trades to non-bank market makers which are very much part of the OTC industry and have a much more aligned method of operation.