Wall Street and the Archegos Capital disaster

What lessons can be drawn in terms of international risk management?

The sudden implosion of Archegos Capital Management in March 2021 is the most important financial disaster of the last five years. Bloomberg Business Week, in an April 8, 2021 article, qualifies the episode as "one of the most spectacular failures in modern financial history."

Archegos was created in 2013 by the very discreet but very active Bill Hwang, as a family office to manage his personal wealth. Bill Hwange had directed Tiger Asia Management in the 2000s and pleaded insider trading in 2012. He was however able to keep $ 200 million which was used to create and then transform Archegos into a hedge fund. As of 2017, Archegos already had nearly $ 4 billion in capital, according to the Bloomberg Businessweek article. In the last quarter of 2020, Archegos had performed very well with shares having gained more than 30% in most of its investments, and in the case of Baidu, Vipshop and Farfetch, more than 70%. The company had thus been able to gain the confidence of major banks offering first-rate brokerage services such as Credit Suisse, Nomura, Mitsubishi UFJ Financial Group, Morgan Stanley and even Goldman Sachs at the end of 2020. Uncertainties about ViacomCBS shares, which had been buoyed by large purchases of Archegos followed by a drop in value, sparked a crisis of confidence with major creditors like Morgan Stanley, which sold $ 5 billion dollars from his holdings with Archegos. A spiral ensued in which other financial partners like Goldman Sachs liquidated $ 6.6 billion in assets. Anyway, the banks that have dealt with Archegos have had to face colossal losses. According to the Wall Street Journal, the loss of Credit Suisse would be around $ 5.5 billion, that of Nomura $ 2.3 billion, that of Morgan Stanley $ 911 million and UBS $ 861 million according to Fortune magazine. Hwang, he would have lost all of his $ 20 billion in two days.

The collapse of an investment firm is not in itself an unprecedented event in the complex world of private equity, nor is it exclusive to Wall Street, as the fall of the powerful Abraaj Capital in 2018 in the United Arab Emirates. The case of Archegos Capital is, however, rich in valuable lessons, both for company directors engaged in operations to enter a new market, in this case that of the United States, and for the management of risks for company managers in charge of international financial market operations.

  1. Good due diligence accompanied by a risk management strategy could have limited the losses incurred by the financial partners who were most exposed. The insider trading to which Mr. Hwang had pleaded guilty in 2012, and the liquidation of his hedge fund in 2012 should have involved less confidence in his leadership and put in place applicable strategies at the slightest warning signal or drift on his part. In this sense, Goldman Sachs bank has been a model of risk management: committing late to limited operations, and acting on the other hand very quickly to protect itself as soon as risks appear. Deutsche Bank, which learned of the many financial scandals in which it had been involved, did the same.

  2. Understanding the differences between one's home market and the local market seems obvious, even if in this case, as The Economist magazine reminds us, in its May 8, 2021 edition (Foreign banks in America: Farce and furious, p. 62), the differences in the functioning of financial markets in the United States, Europe and Asia. It appears in this crisis that the biggest losers have been European and Japanese banks. The big difference is that in the United States economic activity is primarily financed by the capital market, while in Europe and Asia, the economy is primarily financed by bank loans. This difference in investment culture, associated with the knowledge, by local players, of local networks of influence is added to the scale gap between the largest American and foreign players. For example, as The Economist reminds us, the market value of BNP Paribas, the largest European investment bank, corresponds to only 17% of the value of JPMorgan Chase, the largest American bank. In this case, non-US players were at a severe disadvantage in their understanding of the market and their ability to anticipate.

  3. Do not overinvest in a new uncontrolled market: Paradoxically, in the Archegos case, the relatively weak position of foreign banks encouraged them to take more risks to ensure a profitable presence on the American market. Indeed, having fewer possibilities to act in this market, foreign players, also observes The Economist, tend to over-invest in local acquisitions, often paying too much for certain operations, or tend to accept opportunities abandoned by local players, often for reasons of risks which appear obvious to the latter. The Economist mentions, in the banking sector, Deutsche Bank which has continued to finance entities belonging to Donald Trump, while its local competitors had long abandoned them, deeming them too risky.

These lessons are valid for any manager engaged in an operation in markets outside his home market. Whether for an SME, a VSE, an investment office or an industrial group, it is again and again to know how to measure the efforts that will have to be undertaken to succeed in this market level, on the basis of knowledge as precise and above all as up-to-date as possible. We must be very aware that as long as the leader and his structure are not more established or have not interacted for at least 5 or 10 years in a profitable way, this knowledge will inevitably be very incomplete. It will therefore be necessary to be all the more careful in its operations and to initiate as many market intelligence and monitoring actions as necessary to map the situation. Regardless, as with any plan, and like Goldman Sachs in the Archegos case, executives need to have a stop or exit strategy.

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