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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}}. | ''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}}. | ||
And while the goings on it recounts were class-leadingly chaotic — it is hard to believe that the same organisation could have made ''so'' many basic errors, in such scale, for so long, so consistently, missing so many opportunities to cotton on, without catching even ''one'' lucky break as the [[apocalypse]] unfolded around it — | And while the goings on it recounts were class-leadingly chaotic — it is hard to believe that the same organisation could have made ''so'' many basic errors, in such scale, for so long, so consistently, missing so many opportunities to cotton on, without catching even ''one'' lucky break as the [[apocalypse]] unfolded around it — the ''makings'' of all these [[joint and several liability|joint and several]] blunders is imprinted in the structure of ''every'' multinational organisation. | ||
After all, this broker was not alone in taking a hammering. It just took the ''worst'' hammering, and has been the most candid about how. | After all, this broker was not alone in taking a hammering. It just took the ''worst'' hammering, and has been the most candid about how. | ||
This was not an institution that was out of its depth in a market it did not understand. Most of its missteps have a curiously sociological, ''human'' cast to them. Some speak of bad management: poor organisation, unclear responsibilities, fiefdoms and [[silo]]s, under-communication of what mattered, over-communication of what did not; others speak just to ordinary mortal frailty: | This was not an institution that was out of its depth in a market it did not understand. Most of its missteps have a curiously sociological, ''human'' cast to them. Some speak of bad management: poor organisation, unclear responsibilities, fiefdoms and [[silo]]s, under-communication of what mattered, over-communication of what did not; others speak just to ordinary mortal frailty: the thrall of [[Christian name|rank and status]], the fear of speaking up, making management reports and [[dashboard]]s accommodate the risk, rather than making the risk accommodated the models; [[buttocratic oath|backside-covering as a primary goal]], inexplicable insouciance in the face of steadily escalating risk and, when it comes to it, outright [[Mediocre you|mediocrity]] in senior personnel. | ||
The end game sums up how dire the whole sorry business was: In March, 2021, the broker gingerly ''asked'' Archegos to consider a new proposal under which it would recharacterise $1.35 billion of the $2.4 billion in [[excess margin|excess]] [[variation margin]] ''it currently held for Archegos'' as [[initial margin]]: ''asked'', that is, when it was contractually entitled to ''demand'' that, and more, on 3 days’ notice. And, while ''thinking about it'', Archegos systematically demanded CS ''disburse the entire $2.4 billion''. | The end game sums up how dire the whole sorry business was: In March, 2021, the broker gingerly ''asked'' Archegos to consider a new proposal under which it would recharacterise $1.35 billion of the $2.4 billion in [[excess margin|excess]] [[variation margin]] ''it currently held for Archegos'' as [[initial margin]]: ''asked'', that is, when it was contractually entitled to ''demand'' that, and more, on 3 days’ notice. And, while ''thinking about it'', Archegos systematically demanded CS ''disburse the entire $2.4 billion''. | ||
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We like to imagine the conversation went a little bit like this. (''[[Disclaimer]]: this dialogue is entirely made up, but based very loosely on a true story.) | We like to imagine the conversation went a little bit like this. (''[[Disclaimer]]: this dialogue is entirely made up, but based very loosely on a true story.) | ||
{{quote|''It is early March 2021. A ZOOM CALL, conducted between the home office of a RISK OFFICER at CS, who is wearing PPE, wiping his monitor and disinfecting his hands every ten minutes, and a TRADER at ARCHEGOS, who is perched at a bar in the Bahamas nursing a pina colada and multitasking with a game of online poker.'' | {{quote|''It is early March 2021. A ZOOM CALL, conducted between the home office of a RISK OFFICER at CS, who is wearing PPE, wiping his monitor and disinfecting his hands every ten minutes, and a TRADER at ARCHEGOS, who is perched at a bar in the Bahamas nursing a pina colada and multitasking with a game of online poker.'' | ||
CS: Hi, guys. Listen, we are a bit concerned that your risk has got out of hand. We’re badly under-margined. | CS: Hi, guys. Listen, we are a bit concerned that your risk has got out of hand. We’re badly under-margined. <br> | ||
ARCHEGOS: Oh, I see. <br> | ARCHEGOS: Oh, I see. <br> | ||
CS. Yeah. If it’s okay with you, we want to exercise our contractual right to lock up some of your free cash.<br> | CS. Yeah. If it’s okay with you, we want to exercise our contractual right to lock up some of your free cash.<br> | ||
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To be sure, over time, it does trend up, but there are gaping chasms between the peaks — and in any case that’s [[survivor bias]] right there: the game stops the moment you hit zero. So Archegos looked — ''always'' looked — decidedly flakey. | To be sure, over time, it does trend up, but there are gaping chasms between the peaks — and in any case that’s [[survivor bias]] right there: the game stops the moment you hit zero. So Archegos looked — ''always'' looked — decidedly flakey. | ||
Now, I dunno about you, but if one of my customers was that erratic, trading in that size, I’d have a S.W.A.T. team positioned on every nearby roof. Especially a customer with form for insider trading: isn’t the point that you are backing surefire winners? | Now, I dunno about you, but if one of my customers was that erratic, trading in that size, I’d have a S.W.A.T. team positioned on every nearby roof. Especially a customer with form for insider trading: isn’t the point that you are backing surefire winners? | ||
Yet this was not how CS saw it. Archegos got to reputational committees, but the business portrayed Archegos to as a client with “strong market performance” and “[[best in class]]” | Yet this was not how CS saw it. Archegos got to reputational committees, but the business portrayed Archegos to as a client with “strong market performance” and “[[best in class]]” infrastructure and compliance. Even though, as early as 2012 the credit team had identified Archegos’ [[key man]] risk, volatility, mediocre operational management practices, fraud risk, and poor risk management as “significant concerns”. | ||
===Mis-margining=== | ===Mis-margining=== | ||
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. | 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. | ||
*'''[[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: | *'''[[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: | ||
:*[[TRS]] tend to be “[[Bullet swap|bullet]]” swaps with a scheduled termination date and do not “[[re-strike|restrike]]” | :*[[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]]. | ||
:*[[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. | :*[[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. | ||
*'''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 | *'''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=== | ===The greatest fool theory=== | ||
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[[Legal eagles]] will exercise themselves about what happens if a client draws first and asks to withdraw its excess ''before'' you have had a chance to [[Margin adjustment|adjust]] the margin you require, so it cannot. They will say, “well, this would look bad. Optically, you see. How would you explain that to a judge?” | [[Legal eagles]] will exercise themselves about what happens if a client draws first and asks to withdraw its excess ''before'' you have had a chance to [[Margin adjustment|adjust]] the margin you require, so it cannot. They will say, “well, this would look bad. Optically, you see. How would you explain that to a judge?” | ||
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. | 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. | ||
Firstly, we can take it as a given that ''no [[prime broker]] will adjust margins if it thinks it really doesn’t have to'' — why have a difficult conversation now, if things might be better in the morning? If you are running a large [[Margin excess|excess]], generally, you are covered — the security package bites; possession is nine-tenths of the law and, ''In sha’Allah'', things will look better in the morning. | Firstly, we can take it as a given that ''no [[prime broker]] will adjust margins if it thinks it really doesn’t have to'' — why have a difficult conversation now, if things might be better in the morning? If you are running a large [[Margin excess|excess]], generally, you are covered — the security package bites; possession is nine-tenths of the law and, ''In sha’Allah'', things will look better in the morning. | ||
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===Formal versus informal systems=== | ===Formal versus informal systems=== | ||
And here we see the behavioural crux: we tell ourselves that what matters in | 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. | ||
Example: much was made of the unmonitored gap in responsibility between the co-heads of Prime Services. The guy in America thought he was covering ''physical'' prime brokerage. The guy in London thought we was covering ''all'' of prime services, physical and synthetic, but only for EMEA. No-one, ergo, had their eye on ''synthetic'' prime brokerage in America. | |||
Thus, opined the Special Committee, a ''structural'' shortcoming: a formal black spot on the radar. But, come ''on''. This is no failure of organisation. This is not a lapse in formal structure — this is two fallible, mortal humans doing what all fallible, mortal humans do: ''desperately dissembling to duck their patent responsibility for an utter fuck-up''. This is ''plainly'' a post-facto rationalisation: The [[JC]] has known a lot of senior bankers in his time and never yet met one who didn’t run every business he could, and ''claim'' to run every nearby one he couldn’t. Does anyone suppose, for a moment that, had Archegos made the bank a five-and-a-half billion ''profit'', that both these gentlemen would be claiming all the credit God showers on successful investment bankers? | |||
Here is the category error: to substitute a formal structural lapse, because Executive boards understand formal structural lapses: they validate the structure that sits below them; they bestow primacy on those at the top in a way a tendentious human vanity in some random in the organisation doesn’t. You can see, and eliminate, structural gaps. You can solve for them. But if capicious human failings riddle your organinsation; if it can be let down at a moment by vanity, greed, fear or misunderstnanding, by anyone — if its continued success is a reflection of the happy absence of those traits, then what value the members of that executive board? | |||
Not only that, but there is a fundamental asymmetry in the ''degree'' of that softness ''between'' the parties. | Not only that, but there is a fundamental asymmetry in the ''degree'' of that softness ''between'' the parties. | ||
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”. | 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''. | ||
Now clearly, this broker miscalculated how bad the conditions were. But this is not Archegos’ fault, nor the lawyers’. | Now clearly, this broker miscalculated how bad the conditions were. But this is not Archegos’ fault, nor the lawyers’. | ||
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How fared thy numbers, Sirrah? What can you say? <br> | How fared thy numbers, Sirrah? What can you say? <br> | ||
Will a grimace itself engrave upon that storied countenance? What did you lose? Speak. <br> | Will a grimace itself engrave upon that storied countenance? What did you lose? Speak. <br> | ||
GOLDMAN: | GOLDMAN: Nothing, my lord. <br> | ||
KING LEAR Nothing? <br> | KING LEAR Nothing? <br> | ||
GOLDMAN: Nothing. <br> | GOLDMAN: Nothing. <br> | ||