How Bill Hwang got back into banks’ good books — then blew them up

In 2012, New York-based hedge fund Tiger Asia Management pleaded guilty to using inside information to trade Chinese bank stocks, resulting in a massive settlement with US regulators.

It marked a fall from grace for its founder Bill Hwang, one of the so-called “Tiger Cub” veterans of Julian Robertson’s Tiger Management fund.

In theory Hwang might have found himself permanently blacklisted by investment banks everywhere. But just 12 months after he was forced to return money to investors, Hwang was back in the game. He set up a secretive new family office called Archegos Capital Management. And soon many of the world’s top investment banks were fiercely competing for its business.

Banks including Credit Suisse and Nomura on Monday warned investors and regulators that they face billions of dollars in losses from their dealings with Archegos after it defaulted on margin calls. Between them the banks had extended billions of dollars in credit to the family office to allow it to make highly-levered bets on US and Chinese stocks.

As markets around the world digested the shock announcements, bankers and investors were left scrambling to answer a series of questions: why had banks bent over backwards to deal with a hedge fund manager with such a chequered history? How had Archegos managed to stay largely beneath the radar despite amassing large positions in blue-chip names? And what will be the regulatory fallout from the debacle?

“No one has ever seen anything like this before,” said an executive at a Wall Street bank. “The scale, the potential implications for our business, and how so many banks could be so taken-in by either their own greed or by an otherwise interesting investor.”

‘Aggressive, moneymaking genius’Following his brush with the law, initially banks’ risk departments had deep reservations about dealing with Hwang.

Once Hwang started running Archegos, Goldman Sachs took the longest to remove him from its blacklist. The US bank started to work with him again just last year, according to two people close to the matter, but only after years of lobbying by its bankers to convince the risk department to allow it.

Hwang was seen as a compelling prospective client by prime brokers, the potentially lucrative but risky division of investment banks that loans cash and securities to hedge funds and processes their trades.

Concerns about his reputation and history were offset by a sense of the huge opportunities from dealing with him, according to two of Archegos’s prime brokers. He is known as an “aggressive, moneymaking genius”, according to one analyst note, who grew Archegos from assets of about $200m at its 2012 launch to almost $10bn in just nine years.

The fee-hungry investment banks were ravenous for Hwang’s trading commissions and desperate to lend him money so he could magnify his bets. Those included taking outsized positions in stocks such as Chinese technology company Baidu and US media giant Viacom.

“It’s pretty hard for me to defend why we loaned him so much,” said an executive at a bank with billions of dollars of exposure to Archegos.

Nomura on Monday morning warned it was facing $2bn in estimated losses, and Credit Suisse then said its potential losses could be “highly significant and material to our first-quarter results”. Three people close to the Swiss bank suggesting that the eventual figure could reach $3bn-$5bn.

The rapid unravelling of Archegos has led to scrutiny of its relationships with its prime brokers. Goldman and Morgan Stanley led a distressed stock-selling spree of almost $20bn of Hwang’s investments on Friday. Credit Suisse, Nomura and UBS could attempt to offload billions more in stocks this week.

The great unravelling was triggered when Archegos defaulted on margin calls — orders to add cash or collateral to their broker accounts — after a slump in some of its securities. This prompted the banks to liquidate their positions to reduce their exposure to the stocks.

The sell-off has so far impacted nine companies: Baidu, Tencent Music, Discovery, Farfetch, GSX Techedu, Shopify, Vipshop, iQIYI and ViacomCBS. Banks put colossal blocks of the securities up for sale — the largest collection in at least a decade, according to one analyst note.

Derivatives dealingsHow was Hwang able to build such large stakes in companies and remain largely undetected? The answer lies in a type of financial instrument called total return swaps.

Also known as contracts-for-difference, swaps are derivatives that allow investors to pay a fee and in turn receive cash based on the performance of an underlying asset. The bank owns the underlying security and in the event of any losses, payments are due from the hedge fund to the bank.

Swaps have boomed in popularity but have been criticised as they allow investors to amass stakes in companies without disclosing their holdings the way they would have to do with equity stakes of a similar size. They are often used by activist funds to disguise their positions as they build positions in target companies.

Archegos transacted almost exclusively in total return swaps, said several people familiar with the fund’s operations. And it further magnified its footprint by holding the swaps with multiple banks.

Prime brokerages may have not been aware of the extent of their own exposure to Archegos or being racked up at rival banks, said a number of people involved.

“The reality is that prime brokers are still piecing it all together,” said one trader, hours after the block trades first started to hit the market.

Others disputed this. “It’s inconceivable that we loaned him so much or that we were not aware of the other banks’ positions,” said an executive at a bank with billions of dollars of exposure to Archegos.

Fewer than 10 banks racked up more than $50bn of credit exposure to Archegos, said people familiar with the matter.

One Hong Kong-based investor said: “Did any bank know how big this fund was getting and how leveraged it really was? If they did know, why were they still lending at such aggressive terms?”

A number of the banks were lending to Archegos so that it was as much as eight times levered, meaning for every one stock the fund bought, the bank would lend it seven more, according to people familiar with the matter. In some trades, leverage ratios may have hit as high as 20 times, one person with knowledge of the fund said.

It meant that Archegos was able to accumulate large, debt-fuelled positions without either publicly disclosing the positions or owning the underlying security.

“If you’re holding everything as swaps, the reality of what you have to declare to your banks is very little,” said one hedge fund executive with knowledge of trading the instruments.

Despite the limited disclosure, the Archegos affair raises questions about banks’ risk management, which is likely to attract the attention of regulators.

“It’s not so much the quantum of the bank’s lending that is the issue, it’s whether the bank believed it had appropriately hedged itself and whether it was comfortable in the collateral it had taken for the loan in a potential liquidation scenario,” said a senior Wall Street trader.

An executive at a large broker said: “This is why the big banks all blew themselves up in 2008 — over-the-counter derivatives with leverage via a prime broker. Banks are better capitalised now, so this shouldn’t kill any one of them, but it will ruin people’s party and reawaken the regulators.”

One Tokyo-based banker familiar with the situation said: “You get a pretty good understanding of the general situation around Hwang, and the kind of calculations these prime brokers were all making about risk and reward when you look at the way Goldman behaved.”

For years the hedge fund manager was blacklisted by the US bank, which “felt like a no-brainer considering Hwang’s reputation. Then suddenly they are doing everything they can to get him as a client and lend him money,” the banker added.

“So it’s greed trumping fear, right until that stopped last week.”

Written by Tabby Kinder in Hong Kong and Leo Lewis in Tokyo

© Financial Times

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