How Archegos Capital Management lost $20 billion on leveraged positions

A story that made news in recent weeks was how Bill Hwang’s Archegos Capital Management lost $20 billion in a matter of days, triggering severe losses at the firm’s lenders.

Credit Suisse, Nomura, and other big names were exposed to the Archegos portfolio, and when the firm didn’t come up with additional capital, the banks raced to sell shares in the open market. This bulk selling led to much lower prices and massive losses for banks. Credit Suisse alone reported a loss of CHF 4.4 billion ($4.77 billion).

Luckily, the event didn’t create systemic risk, but it matters to currency traders because safe-haven currencies such as JPY and CHF rise as risk-off dominates.

A lesson about leverage

Risk-seeking investors will always use leverage to increase their capital as quickly as possible. But leverage works both ways: it increases the risk as well as the potential return.

The Archegos “family firm” structure allowed it to anonymously use swap contracts to quickly leverage its positions using aggressive margin in a bullish market. This is not new among hedge funds, but in this case, Archegos bought more as markets rose and more capital was freed up.

The bubble burst when one of the main holdings, ViacomCBS, announced a $3 billion stock scale that triggered a massive 30% slide in the company’s shares. Archegos couldn’t come up with new capital to meet its margin call, so it and its banks had to sell stocks from the portfolio. Some escaped relatively unscathed, but Nomura and Credit Suisse did not.

The moral of the story

FX trading is done on leverage, and pyramiding freed-up funds into winning positions is okay as long as there is enough cash to cover any margin call. Risk management is key, and this is where Archegos and its banks fell down. The question for regulators is: how can one family firm be responsible for reputable investment banks losing so much money?