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Credit Suisse’s margining methodology for swaps was, from the outset, positively moronic. The JC is a legal eagle, not a credit guy, but even I could spot the flaws in this. | Credit Suisse’s margining methodology for swaps was, from the outset, positively moronic. The JC is a legal eagle, not a credit guy, but even I could spot the flaws in this. | ||
*[[TRS]] not [[synthetic equity]]: CS appears to have documented the trades as “total return swaps” under a standard equity derivatives master confirmation agreement, and not synthetic equity derivatives under a portfolio swap master confirmation. The differences are subtle, but there are two in particular: TRS tend to be “bullet” swaps with a scheduled termination date and as a result do not “[[re-strike|restrike]]” before maturity, and are [[static margin|statically margined]]. Portfolio swaps are designed to replicate cash prime brokerage; there is not a specified maturity date, so the notional restrikes periodically (like, monthly), and [[initial margin]] is calculated daily against the prevailing “{{eqderivprov|Final Price}}” rather than the original “{{eqderivprov|Initial Price}}”. As Hwang’s positions appreciated, the margin value as a proportion of the position eroded, and Hwang apparently used the [[variation margin]] to double down on the same trades, pushing the equity price further up, exacerbating the problem. | *[[TRS]] not [[synthetic equity]]: CS appears to have documented the trades as “total return swaps” under a standard equity derivatives master confirmation agreement, and not synthetic equity derivatives under a portfolio swap master confirmation. The differences are subtle, but there are two in particular: TRS tend to be “bullet” swaps with a scheduled termination date and as a result do not “[[re-strike|restrike]]” before maturity, and are [[static margin|statically margined]]. Portfolio swaps are designed to replicate cash prime brokerage; there is not a specified maturity date, so the notional restrikes periodically (like, monthly), and [[initial margin]] is calculated daily against the prevailing “{{eqderivprov|Final Price}}” rather than the original “{{eqderivprov|Initial Price}}”. As Hwang’s positions appreciated, the margin value as a proportion of the position eroded, and Hwang apparently used the [[variation margin]] to double down on the same trades, pushing the equity price further up, exacerbating the problem. | ||
*'''They didn’t keep an eye on the direction of the portfolio''': Archegos at first used the swap book to put on short positions that offset the long bias on its cash book. It used this bias to argue for lower margins — a request the business accommodated, provided the combined portfolio bias did not exceed 75% long or short. Over time Archegos | *'''They didn’t keep an eye on the direction of the portfolio''': Archegos at first used the swap book to put on short positions that offset the long bias on its cash book. It used this bias to argue for lower margins — a request the business accommodated, provided the combined portfolio bias did not exceed 75% long or short. Over time Archegos frequently exceeded these limits, often for months at a time, but CS took no action, accepting Archegos’ promises to correct the bias. | ||
*'''They didn’t take ''enough'' margin''': Archegos pressured CS to lower its swap margins, citing more favourable margins it was getting from other brokers due to the effect of [[cross-margining]]. | *'''They didn’t take ''enough'' margin''': Archegos pressured CS to lower its swap margins, citing more favourable margins it was getting from other brokers due to the effect of [[cross-margining]]. | ||
===The greatest fool theory=== | |||
You read variations of the following a ''lot'' in the Archegos report: “if we increase margins [to risk-acceptable levels], we will lose the business”. Indeed, you will hear variations of that theme, every day, uttered by anxious [[salespeople]] in every brokerage in the City. Salespeople ''would'' say this: their ''role'' is to say things like this: they speak for their clients, and their own bonus prospects, at the table where business is discussed. But others at that table — notably risk — should be taking the other side of that conversation. | |||
So should your risk team be led by ex-salespeople with no experience in risk management? Probably not. Should it be business-aligned at all? Interesting question. | |||
In any case it seems the fears of CS risk executives, that they might be uncompetitive if they raised margins, was flat out wrong. To the contrary, Archegos directed business to CS ''because'' it was margining swaps more cheaply than anyone else. | |||
There is an argument that the guy who wins an auction is the stupidest guy in the room. To the broker who lowballs more circumspect peers, the spoils, but at a price its peers consider beyond the pale. Brokerage is an annuity business: it is picking up pennies in front of a steamroller. Credit Suisse found 20 million dollars of pennies in front of the steamroller in a year. The steamroller did it five and a half billion dollars of damage overnight. | |||
Archegos switched positions away from other brokers and to Credit Suisse because CS offered the tightest margins. | |||
Let this be the lesson: sometimes losing business is not such a bad thing. | |||
===Had weapons. Didn’t use them.=== | ===Had weapons. Didn’t use them.=== | ||