Archegos: Difference between revisions

To assist with nerves in the risk department, the synthetic equity swap [[re-strike]] periodically (like, monthly), meaning you rebase your initial margin, even if static, to the prevailing price of the stock each period, undoing any “margin erosion” that might otherwise have occurred due to the appreciation of the position. Not only that, but [[initial margin]] isn’t static: it is dynamic; calculated daily against the ''prevailing'' “{{eqderivprov|Final Price}}” rather than the ''original'' “{{eqderivprov|Initial Price}}”.  

====When variation margin attacks====

====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.

{{quote|''Archegos’s long bias was driven by the evolution of its swaps portfolio. Given the substantially reduced swap margin, Archegos began putting on long swaps (at the new lower margin) with CS, whereas it had historically held its long positions in Prime Brokerage (at a higher margin rate). The lower swap margins—which Archegos assured CS were “pretty good” compared to what its other prime brokers required—no doubt led Archegos to trade more swaps with CS, and Archegos’s holdings at CS increased markedly.''}}

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, as CS’s was, by ex-salespeople with no experience in risk management? Probably not. Should it be business-aligned at all? Interesting question.

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.

{{quote|''At the same time, the contractual protections CS had negotiated with Archegos were illusory, as the business appears to have had no intention of invoking them for fear of alienating the client.''}}

{{pb margining capsule}}

I’m not so sure it ''would'' look bad. A commercial court would understand it [[Commercial imperative|quite simply]]. ''This is how service contracts work''. It is a relationship business. One keeps one’s powder dry.  

If, and only if — ''when'', that is to say — the client asks for all its excess back must we confront our demons and deliver bad news. At that point, we can decide, ''do we blow up our relationship, now or not?''  

And here we see the behavioural crux: we tell ourselves that what matters in risk management are the formal boundaries we draw; the official channels; the technical superstructure of the relationship; the architecture of the parties’ rights and obligations versus each other. But this isn’t true. In practice the relationship is governed by soft, morphing, invisible, ''informal'' boundaries, good and bad. Interpersonal relationships. Insecurities. Understandings. ''Mis''understandings. Past practices. Fear of screwing up. Precedents. Arse-covering. Expectations. Self-serving narratives. Trust. The [[commercial imperative]].<ref>This isn’t the place for it, but note: these fundamental qualities of commercial life are utterly [[Legible|illegible]] to [[neural networks]], [[Policy|policies]] and [[algorithm]]s.</ref> These things don’t show up in org charts or on [[opco]] [[deck]]s. You can’t measure them. To try is to get the wrong end of the stick.

Much was made of the unmonitored gap in responsibility between CS’s co-heads of prime services.<ref>“Co-heads is ''no'' heads”.</ref> The guy in America was a stocks specialist. He wasn’t big on swaps. He thought he was covering ''physical'' prime brokerage only. The guy in London was an old-school European: he thought he was covering ''all'' of prime services, physical and synthetic, ''but only for EMEA''.  

Board members can see, and eliminate, structural gaps. They can solve for them. But if a perfectly sound machine can be upended to the tune of of five billion dollars by the kinds of quotidian human failings that ''riddle'' every organisation; if the whole machine can be blown up by a moment of uncontrolled greed, fear, misunderstanding or just ''stupidity'' by ''anyone'' in the organisation,<ref>None of Jerome Kerviel, Nick Leeson, Yasuo Hamanaka, Kweku Aboldoli were senior executives.</ref> ''however'' robust its formal structure, then what real value the members of that executive board? Are they master pilots, or chimpanzees strapped to a rocket?

Not only that, but there is a fundamental asymmetry in the ''degree'' of that softness ''between'' the parties.  

Now clearly, this broker miscalculated how bad the conditions were. But this is not Archegos’ fault, nor the lawyers’.

{{apocalypse maxim}}

I mean, out of the mouths of babes. There was quite a bit of human wreckage at CS in the aftermath, but you really hope the author of that email wasn’t part of it. But the wider point is this: when all is plain sailing, you can, if you wish, operate a complex business through the agency of cheap staff in remote locations with an instruction manual, which you hope has been suitably translated into Bulgarian. But the thing about complex businesses navigating open water is that ocean weather can quickly change, and a quiet potter around the heads can turn into a Fastnet tempest, and then your Bratislavan school-leavers are going to be hopelessly out of their depth. Relying on rigid application of [[playbook]], [[policy]], [[Process|processes]], [[system]], [[algorithm]] or work-to-rules especially when, as it happens, your senior management are disinclined to enforce them properly anyway, is no way to survive a hurricane.

Thye episode is a masterclass in how organisations work; how people in positions in responsibility are propelled by internally-constructed [[second order derivative]]s of the risks they are meant to be monitoring: what matters is not ''what happens'' nor ''holding adult conversations with customers, even where that requires delivering unpalatable truths'' but that ''I should not be held responsible for what happens'', a state of affairs one can vouchsafe by ensuring one follows internal models, policies and diktats regardless of their absurdity or fitness for purpose. There is a tension, between Sales on the one hand, whose north star is ''do not upset the client'', and senior management, whose is ''make sure all the RAG indicators are green''.

So, to deal with the problem that Archegos was persistently breaching its stress limits with one CS entity, the solution was to repaper it with another one that had a higher stress scenario appetite. This was an opportunity to head off a coming crisis a year out. inflection point: ''wrong decision''. When, after the migration, Archegos was ''still'' substantially in breach of its scenario limit, the business switched from the extreme “Severe Equity Crash” scenario to the more benign “Bad Week” scenario. Even then, six months from disaster, Archegos’ “Bad Week” exposure was still double the $250m limit. Another bad [[decision]].  

As balloon continued to resist tactical squeezing, and in the wake of the Malachite failure a year earlier, management adopted the “People’s Front of Judea gambit” and, in an initiative to “identify early warning signs of a default” and “enhance its controls and [[escalation]] framework across functions during periods of stress,” the broker created a new committee. The job of the Counterparty Oversight Committee (“CPOC”), was to “analyse and evaluate counterparty relationships with significant exposure relative to their revenue generation and to direct remedial measures where appropriate”.

{{ref}}

{{c2|Risk|Prime Brokerage}}