Archegos Capital Management Fund initiated a $30 billion fire sale in the stock market on Monday, resulting in two rough days for investors and potentially costing two investment banks millions of dollars.
The massive selloff started as the result of something called a total return swap, a form of derivative that allows an investor to enter fixed payment agreements (Investor A) with another party (Investor B) over a security. If that security rises in value, Investor A receives the equivalent amount in payment from Investor B.
However, if the security falls in value, Investor A will owe the difference between the current value and the value at the time of the deal to Investor B. This allows hedge funds and investment groups to take relatively large positions on securities without disclosing their positions to the public or putting up a significant amount of capital.
The downside is that should a security fall significantly in value, the margin call resulting from a large position in a swap could outweigh what a fund has available in liquid assets. That is exactly what happened to Archegos on Monday.
The fund had made large deals with multiple investment brokers on U.S. based media stocks, particularly ViacomCBS and Discovery. The meltdown began when Viacom’s $3 billion stock offering last week fell through, causing investors to call in their margins on the total return swap.
With no capital to cover the large margins that were called in, Archegos began off-loading large portions of its investments to make up the difference.
This fire sale hit most of the U.S. market, affecting all three stock indices and sending U.S. tech firms into a day of losses. The liquidation also hit investment banks, with Credit Suisse and Nomura Holdings both reporting “significant” losses on Monday.
Credit Suisse and Nomura both told reporters that “a U.S. based investment firm” had defaulted on margin calls, but did not give a name. Reports from the Wall Street Journal and CNBC both cite internal sources that allege the margin defaults were related to Archegos.
Neither bank has formally acknowledged how deep their losses are, but Credit Suisse did tell reporters that the losses could be “highly significant and material” to their first quarter results.
Other large investment banks managed to avoid heavy losses by quickly offloading Archegos related shares. Deutsche Bank reported that they have seen zero losses from the meltdown, while Goldman and Morgan Stanley did see slight drop offs in their stock price following the news.
Archegos Capital Management was created by Bill Hwang, a former analyst for famous hedge fund manager Julian Robertson. Hwang is part of the so-called tiger cubs, a group of investment bankers mentored by Robertson, who is considered one of the greatest investment managers of all time.
Prior to running Archegos, Hwang built and maintained Tiger Asia Management, a hedge fund that invested heavily in Asian markets. Hwang ran Tiger Asia from 2001 until 2012, when he pleaded guilty to insider trading of Chinese securities. Hwang then paid a $44 million fine and closed Tiger Asia. He would then open Archegos in 2013.
Investors are optimistic that the effects of the meltdown are largely over and do not appear to have affected the market in the long term. As the dust settles, investment banks will likely keep their distance from the now radioactive Archegos as congressional finance leaders like Elizabeth Warren bring regulation talks to the table.