Archegos indictment raises new questions about banks’ risk management controls – Reuters | Region & Cash

NEW YORK, May 2 (Reuters) – New details revealing how Archegos Capital Management founder Bill Hwang hid his fund’s extreme exposure from his lenders raise new questions about the risk management policies of these global banks, formers said regulators and risk experts.

Hwang and Archegos Chief Financial Officer Patrick Halligan were arrested Wednesday on charges of lying to banks to increase Archegos’ lines of credit and using the money to increase their exposure to a handful of stocks they own also tampered with, according to a complaint from the Justice Department. Continue reading

The couple strenuously deny all allegations.

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Archegos defaulted in late March 2021 after the value of its businesses fell and banks canceled their lines of credit, leaving global lenders including Credit Suisse AG, Nomura Holdings (8604.T), Morgan Stanley (MS.N) and UBS Group AG ( UBSG.S), with a total loss of around $10 billion.

While the Justice Department portrays the banks as victims of being lied to by Archegos executives, the indictment reveals red flags the banks could have acted on to reduce their exposure to Archegos’ aggressive dealings, risk experts said.

These include the Fund’s unwillingness to disclose certain details about its portfolio; his failure to provide evidence to support his claims; the surge in some Archegos shares; and the Fund’s frequent breaches of credit limits.

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

Those defaults could potentially lead to some banks being hit by civilian regulators, some experts have speculated.

A Justice Department official told reporters last week he could not comment on whether the banks were facing further repercussions. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission, which also filed civil complaints Wednesday, declined to comment Monday.

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

Archegos built a highly concentrated exposure to a handful of stocks using equity swaps written by banks. Its positions were heavily leveraged, up to 1,000% in some places, the SEC said.

Archegos traded through up to nine banks. Because the fund was not legally required to report its total exposures, number of lenders, or its swap positions, each bank only had visibility into Archegos’ activities at their firm.

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

Still, in many cases, signed certificates or even word from Archegos were good enough for the banks to obtain additional credit beyond the limits previously set by the banks, the indictment shows.

For example, in February and March 2021, UBS increased Archegos’ trading limits, based in part on the fund’s assurances that contained false information about its concentration in certain stocks and its liquidity, the indictment said.

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

The Federal Reserve alluded to these shortcomings in a December statement on the scandal, warning lenders against accepting “incomplete and unverified information” from funds and that such “practices constitute insufficient due diligence.”

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

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

At one point, Archegos held more than 30% of Discovery Inc’s daily volume and 50% of ViacomCBS’s free float, which significantly changed its shareholder mix, the indictment said.

The massive surge in the price of these companies for no apparent fundamental reason should have raised eyebrows, Copeland said.

Those spikes, combined with Archegos’ rapid increase in capital and portfolio size, should have prompted a review of underlying risks and effective leverage, Lam said.

Alma Angotti, a partner at risk management consultancy Guidehouse and a former SEC enforcement officer, said that although banks have been lied to, regulators may still be examining whether their risk management programs are inadequately designed or implemented.

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

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Reporting by Elizabeth Dilts Marshall; Edited by Michelle Price and Nick Zieminski

Our standards: The Thomson Reuters Trust Principles.

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