Explained: What caused US hedge fund to blow up & how it can affect markets

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Explained: What caused US hedge fund to blow up & how it can affect markets


MUMBAI: The turbulence at Archegos Capital Management, run by former hedge fund manager Bill Hwang, has sent shockwaves across financial markets from Singapore to New York.

The family office based in New York was reported to be behind the ‘unprecedented’ block trades that took place on Friday in the US markets. Investment banks such as Goldman Sachs and Morgan Stanley dumped over $20 billion worth equity positions on behalf of Bill Hwang’s fund in a series of block trades that caused trepidation among traders.

The risk of the contagion from the blow-up of the family office is worrying investors after its primary brokers such as Nomura Holdings and Credit Suisse gave profit warnings early Monday from a huge potential loss from a US-based fund, which was reported to be owned by Bill Hwang. Shares of Credit Suisse and Nomura suffered as they plummeted more than 13 per cent on Monday.

  1. What triggered Goldman Sachs’ massive block trade?
    On Friday, traders in New York were jolted amid rumours that Goldman Sachs carried out block trades worth over $10 billion in shares of some of the biggest entertainment stocks and American Depository Receipts of Chinese companies.

    Block trades are routine affairs in the market, and as such, they do not raise eyebrows. However, in this case the sheer size of the individual market orders were so large that traders smelled a rat. Stocks in which the block trades happened collapsed with some seeing losses of more than 40 per cent on Friday.

  2. Who was the seller behind $10 billion margin call?
    Bloomberg News and New York Times over the weekend separately reported that the massive block trades conducted by Goldman Sachs and Morgan Stanley on Friday were on behalf of Archegos Capital. It turned out that Goldman Sachs and Morgan Stanley, who were among the primary brokers of Archegos, were in effect dumping the positions of Hwang’s fund in the market due to a margin call.
  3. What is a margin call?
    A margin call is an event wherein, the broker of an individual is forced to liquidate the positions of a client in the event the client is not able to furnish additional cash to cover margins on his leveraged trade.
  4. Who is Bill Hwang?
    Bill Hwang is a former hedge fund manager who worked for the illustrious investment firm Tiger Management. Hwang’s past is checkered. In 2012, he entered a settlement with the Securities Exchange Commission following charges of making illicit profits from his trade in Chinese bank stocks that saw him fork out $44 million along with another colleague.

    After his hedge fund collapsed, Hwang started a family office under Archegos Capital with leverage-based bets on US technology growth stocks and Chinese ADRs. Bloomberg reported that Hwang’s long-short strategy meant he took large positions in some of the biggest stocks listed in the US through private derivative contracts that allowed him to take exposure which was multiple times his initial capital.

  5. What went wrong at Archegos?
    The bespoke derivative contracts Hwang used at Archegos Capital to enhance his market positions were at the epicenter of the financial crisis of 2008-09, and yet Hwang’s primary brokers such as Nomura, Credit Suisse and Goldman saw no harm in extending such margins to an individual charged with fraud.

    But the market’s direction recently may have gone against Hwang’s leveraged positions in the market resulting in mark-to-market losses. Since Hwang had to provide margin to cover for the leverage, the losses resulted in his brokers calling for more cash. Market participants said while Hwang’s primary brokers had collaborated in providing leverage to Archegos Capital, it is possible that Goldman and Morgan Stanley broke rank and chose to recover their capital by dumping Archegos Capital’s positions in the market.

  6. Will Archegos fallout trigger contagion globally?
    While equity markets have so far been able to take the collapse of Arhcegos in its stride, profit warnings issued by Nomura and Credit Suisse are raising concerns of a wider contagion. Goldman Sachs has reportedly told its investors that the losses from its exposure to Archegos are immaterial.

    Market participants are more concerned with the second order effect of the episode, as they believe this trigger tightening of margin requirements globally by investment banks, which may trigger deleveraging in markets that have seen high level of margin funded trading in recent months.

    Investment bankers may start compiling lists of other hedge funds who may have taken large leverage-based exposure and try to minimize the threat to their balance sheet by winding down on leverage provided by them to hedge funds till the Archegos storm blows over.

    Deleveraging by hedge funds could be sobering news from emerging market equities as it may reduce inflows or worse, trigger outflows as funds look to pare down risky exposure in the market. Combine that with the head-scratching strength in the US dollar, which is anyway pressuring carry trades, and the effects of this episode may get messy.



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