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| {{a|eqderiv|{{catbox|Equity Derivatives|Risk|Prime Brokerage}}}}{{quote|No. It’s still too soon. | | {{essay|disaster|Archegos|{{image|disaster cafe|jpg|<br>“Can I have my refund ''before'' I pay for the meal?”}} }} |
| :—JC, June 2019.}}
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| ''Later...''
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| {{Quote|It is no longer too soon, for on July 29, 2021 the Credit Suisse Special Committee to the Board of Directors has presented its ''{{plainlink|https://www.credit-suisse.com/about-us/en/reports-research/archegos-info-kit.html|Report on Archegos Capital Management}}'' to the board and, for some reason known only to the board,<ref>''What on Earth did they think they would achieve by releasing this report?'' It caused ''another'' precipitous drop in the firm’s stock price — nearly four percent — to go with the twenty percent drop it suffered when news of the default first broke.</ref> they have published to it to the known world. This seems to be a final act of self-harm from an organisation whose serial acts of self-harm the report catalogues in such clinical, precise detail. | |
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| That said, it is an act of self-harm for which the watching world should feel tremendously grateful. Not only a sizzling read, arriving just in time for Bank executives as they head for a fortnight to the sun loungers of Mykonos and Ibiza, but it is a beautifully clear explanation of the business of [[equity prime brokerage]] in particular and global markets broking in general, and a coruscating dismemberment of the way investment banking operates, both inside Credit Suisse and without.
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| :—JC, July 2019}}
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| This is a proper horror story, make no mistake: Stephen King has not a patch on this.
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| ''Everyone'' involved in the business of prime services, and global markets broking generally, should read {{plainlink|https://www.credit-suisse.com/about-us/en/reports-research/archegos-info-kit.html|the Credit Suisse Report}}. | |
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| And while the goings on at this brokerage were breathtakingly, class-leadingly chaotic — it is hard to believe that any one organisation could have made ''so'' many unforgivable errors, in such scale, over such a long period, so consistently, missing many opportunities to cotton on, without catching even ''one'' lucky break as the apocalypse unfolded around it — this really is a royal flush of idiocy — the ''makings'' of all these [[joint and several liability|joint and several]] catastrophes is imprinted in the DNA of ''every'' multinational organisation. An onlooker who denies it — who does not shudder and think, ''there, but for the grace of God, go I'' — is showing ''precisely'' the lack of awareness that caused this situation.
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| After all, this broker was by no means alone in taking a hammering in the fallout from Archegos.<ref>Famously, of all the brokers, Goldman fared bestr, suffering “immaterial losses”. This may well be superior risk management practice — it’s Goldman, right? — but may have something to do with the fact that, according to the Credit Suisse report, Goldman didn’t have Archegos on its books at all until at least April 2020 </ref> It just took the ''worst'' hammering, and has been the most candid about why. Its special committee makes a number of excellent recommendations — all worth heeding — but stops short of the one that must have been most tempting to the Board: ''get the hell out of the broking business altogether''.
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| Almost all the most egregious errors were sociological, and not systemic: they speak of human foibles, the thrall of power, human seduction by the simplicity of models and the internal primacy afforded to capital calculations — a proxy means of measuring ones ability to withstand catastrophe and not avoiding catastrophe as an end in itself — with arse-covering, deference to hierarchy, fiefdoms and silos, inexplicable insouciance in the face of steadily escalating risk and, when it comes to it, outright idiocy.
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| This sums up how dire the whole sorry business was: In early March, 2021, the broker gingerly ''asked'' Archegos to consider a new margin proposal under which the broker would take $1.35 billion of ''funds it currently held for Archegos'' and recharacterise them as [[initial margin]]: ''asked'', that is, when it was contractually entitled to ''demand'' that, and more, on 3 days’ notice.
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| Archegos promised to consider the request but, meanwhile, demanded the broker pay ''out'' $2.4 billion in excess [[variation margin]] it was holding. And, two weeks before Archegos blew up causing this broker a $5.5billion loss, the broker paid the excess variation margin out.
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| If that isn’t painful enough, Archegos then used that excess to put on a further billion and a half dollars in additional long positions in the same stocks with Credit Suisse.
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| Breathtaking.
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| ===Concerns about Archegos===
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| *'''Trustworthiness''': Between 2012 and 2014 [[Bill Huang]] and his Tiger Asia fund was convicted of wire fraud, settled charges of [[insider trading]], and was banned from the Hong Kong securities industry for four years. Huang was only able to continue by returning all outside capital to its investors and “rebranding” as a family office exclusively running Huang’s own (and, well, his prime brokers’) money.
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| *'''Skill''': Over the 10 years between the insider trading debacle and the final collapse, Archegos suffered multiple massive drawdowns. Extreme volatility which sounds like Huang had no real skill as a money manager, and was rather riding around like a child holding a firehose of leverage.
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| *'''Controls''': As early as 2012 the Credit team had identified Archegos’ [[key man]] risk (in Huang), volatility, mediocre operational management practices, fraud risk, and poor risk management as significant concerns.
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| ===Mis-margining===
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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 ''he'' could spot the flaws in this.
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| *'''[[TRS]] not [[synthetic equity]]''': CS appears to have documented the trades as “[[total return swap]]s” under a standard [[equity derivatives]] [[master confirmation]], and not as “[[synthetic prime brokerage]]” under a portfolio swap master confirmation. The differences are subtle, but there are two in particular:
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| :*[[TRS]] tend to be “[[Bullet swap|bullet]]” swaps with a scheduled termination date and do not “[[re-strike|restrike]]” their notional before maturity, and they are [[static margin|statically margined]].
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| :*[[Portfolio swap]]s are designed to replicate cash [[prime brokerage]]; the investor does not have a specified maturity date in mind at the outset, and may keep a swap on for a day or five years, so the broker is completely in the dark as to the likely tenor of the trade. This makes fixing an amount of margin upfront fraught. To assist with nerves in the risk department, the notional of synthetic equity [[re-strike]]s periodically (like, monthly), and [[initial margin]] is calculated daily against the ''prevailing'' “{{eqderivprov|Final Price}}” rather than the ''original'' “{{eqderivprov|Initial Price}}”. Archegos swaps were, typically, bullet swaps margined with a fixed amount up front. As they appreciated, the margin value as a proportion of their prevailing value eroded. Archegos apparently used the [[variation margin]] it was earning through those appreciating positions to double down on the same trades — ''also'' static margine — pushing the equity price further up, exacerbating the problem. His swap portfolio was a ticking time-bomb.
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| *'''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.
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| *'''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]].
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| ===The greatest fool theory===
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| {{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.''}}
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| Here is a sort of convexity risk: If you offer the most favourable terms on the street, then customers will tend to put their positions on with you. If your swap margins are lower than your [[cash brokerage]] margins, your customers will tend, [[all other things being equal]], to put their positions on swap. Water runs downhill.
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| 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.
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| 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.
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| 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.
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| 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.
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| Archegos switched positions away from other brokers and to Credit Suisse because CS offered the tightest margins.
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| Let this be the lesson: sometimes losing business is not such a bad thing.
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| ===Had weapons. Didn’t use them.===
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| {{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.''}}
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| ===Formal versus [[informal systems]]===
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| 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. Interpersonal relationships. Understandings. Past practices. Precedents. Expectations. 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>
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| Not only that, but there is a fundamental asymmetry in the ''degree'' of that softness ''between'' the parties.
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| The relationship, after all, is one of service provider and customer: the customer sees its rights and obligations largely as hard-edged economic options, which it is free to exercise without regret, regardless of their impact on “the house”. Thus, Archegos was entitled to withdraw excess variation margin, and its broker had little option but to comply ''''without “blowing up the relationship”''. On the other hand, the broker’s right to recalibrate [[initial margin]], whilst framed as an equally clear option, was nothing of the kind. It was implicit in the [[commercial imperative]] that the right would lie untouched ''unless the conditions justifying exercise were so unbearably dire as to give the broker no plausible alternative''.
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| Now clearly, this broker miscalculated how bad the conditions were. But this is not Archegos’ fault, nor the lawyers’.
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| The broker is a ''service provider''; it wishes the client only well. It presents its risk management parameters (for example, rights to raise margin) not as targets it intends to hit mechanistically of their conditions are triggered, but last resorts it will deploy with a heavy heart and ''only if calamity otherwise awaits''.
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| So while a contractual right held by the client more or less means exactly what it says, the broker it draws its formal boundaries well ''inside'' the area it is prepared to let the client, in practice, wander. ''[[NAV triggers]] are never exercised''. If the client approaches the edge of that wider area — a ''real'' point of no return for the broker — the broker will not mechanicistically pull triggers and detonate positions: instead, it will reason with the client, realising that precipitous action/
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| ===The broker that didn’t bark in the night-time===
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| {{Quote|KING LEAR: Now, our joy,
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| Although the last, not least; to whose young leverage <br>
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| Thine holdings in thinly traffick’d names, rich in outrageous voguery, dry of <br>
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| Bunch, distil, concentrate: conspire their margin lenders to o’er-extend;<br>
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| How fared thy numbers, Sirrah? What can you say? <br>
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| Will a grimace itself engrave upon that storied countenance? What did you lose? Speak.
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| GOLDMAN: Nothing, my lord.
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| KING LEAR Nothing?
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| GOLDMAN: Nothing.
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| KING LEAR: Nothing will come of nothing, fair squidly vampire: speak again.
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| :—Shakespeare: ''Tiger King Lear'', I, iii}}
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| What follows is heavily derivative and based on assumptions and extrapolations from a single footnote and may — most likely is, in fact — entirely mistaken. Nevertheless, even if it is, it illustrates an interesting hypothetical.
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| {{archegos goldman}}
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| ===Red flags===
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| *[[Key person]] risk
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| *[[Volatility|Volatile]] performance
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| *Mediocre operational management practices
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| *Fraud risk
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| *Poor risk management practices and procedures
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| {{sa}}
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| ''{{plainlink|https://www.credit-suisse.com/about-us/en/reports-research/archegos-info-kit.html|Report on Archegos Capital Management}}''
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| *[[Informal systems]]
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| {{ref}}
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| {{c|Risk}}
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