Credit Suisse Tightens Hedge Fund Lending As Senator Demands “Answers” From Banks On Archegos Blowup

Reports about regulators (including the SEC in the US and the FCA in the UK) grilling the banks involved in the Archegos Capital Management blow up emerged just days after the $20 billion “family office” suffered an epic margin call that sapped all of its capital as brokers dumped blocks of shares as fast as they could, even as Morgan Stanley and Goldman Sachs beat them to the punch.

As academics and former regulators chirped in the press about the need for more stringent reporting requirements for family offices (essentially private hedge funds comprising the wealth of a single individual or family), and more regulation of OTC derivatives trading, some joked that the main players would inevitably be dragged in front of the Senate Banking Committee for a hearing, as if they were the founders of Citadel, Robinhood or Facebook.

The world came one step closer to that reality Thursday when the FT reported that Sherrod Brown, a progressive Democrat from Ohio and chairman of the Senate Banking Committee had written to four major banks, including Goldman, Morgan Stanley, Credit Suisse and Nomura (based in Switzerland and Japan, respectively), seeking “answers” about how Archegos Capital managed to amass so much leverage without any of its prime brokers realizing the firm was repeatedly borrowing against the same collateral (for more on that, click here).

Brown is seeking information about Archegos, and family offices more broadly. So far, banks who lent to Archegos have reported $7.5 billion in losses and analysts at JPM fear those losses could climb to $10 billion.

“I am troubled, but not surprised, by the news reports that Archegos entered into risky derivatives transactions facilitated by major investment banks, resulting in panicked selling of stocks worth tens of billions of dollars and those banks collectively losing nearly $10 billion,” Brown said in his letter to Crystal Lalime, general counsel at Credit Suisse.

“The details and ultimate consequence of Archegos’s failure remain to be seen, but the massive transactions, and losses, raise several questions regarding Credit Suisse’s relationship with Archegos and the treatment of so-called family offices, Hwang’s history, and the transactions that have been mentioned in news reports,” Brown added.

The letter follows Credit Suisse’s announcement on Tuesday that it would slash its dividend to help offset the impact of the $4.7 billion loss it booked from its Archegos trades (here’s how CS managed to lose that much).

Just as we anticipated, Bloomberg reported Thursday that Credit Suisse is tightening lending terms for hedge funds and family offices, in a potential harbinger of a new industry-wide practice, and a major U-turn from the steady loosening in lending standards as yield-starved banks grasped for profits in recent years. As we expected, CS is reportedly switching from “static margining” to “dynamic margining”, which could force clients to post more collateral and reduce the profitability of some trades.

Typically, clients lock in margin terms on swap agreements for a fixed period, say 60 or 180 days. But the Zurich-based bank – Switzerland’s second-largest bank after crosstown rival UBS – is asking some clients to move to the new terms immediately, according to Bloomberg’s sources.

News of CS’s move to “de-risk” brings to mind a warning from Guggenheim’s Scott Minerd, who said he fears another Archegos-style blowup is “highly likely,” Well, by upping margin requirements, CS will effectively force firms to deleverage by unwinding their gross and net exposure substantially. This likely means lots of ‘smart money’ selling is ahead. 

And the next blowup might be closer at hand than we expect, as JPM dumps a block of $ASO shares after hours on Thursday, prompting Bear Traps report author Larry McDonald to muse:

Every hedge fund compliance officer across the Street is now in search of the next Archegos, and they have as much trust in their prime broker as the lovely Marylin Monroe had in the playboy that was JFK. There are times to take on more risk and other inflection points which whisper into the wise man’s ear, “reach across the velvet and pull some chips off the table.” This is one of them, let the mad mob chase.

For much of the last six months we have been in the growth to value camp, pounding the table on the migration of capital running out of Big Tech over to equities in the commodity sector. As most of our long term clients know, we have never been more bullish. Our focus has been on rotation – NOT a drawdown leaking across asset classes. Today, we must make a stand. It’s time to take down risk positions across the board and let the fools chase.

For now, we will be waiting for the next shoe to drop on $ASO.

Circling back to Brown, let’s remember that he isn’t the only Senate Democrat sniffing around. Elizabeth Warren, who, like Brown, sits on the influential Senate Banking Committee, has raised concerns about the situation during an interview with CNBC, where she said the blowup had “all the makings of a dangerous situation – largely unregulated hedge fund, opaque derivatives, trading in private dark pools, high leverage, and a trader who wriggled out of the SEC’s enforcement.”

“Regulators need to rely on more than luck to fend off risks to the financial system: we need transparency and strong oversight to ensure that the next hedge fund blow-up doesn’t take the economy down with it,” she added.

Earlier this week, former FDIC chief Sheila Bair told CNBC that Archegos is a symptom of banks’ shoddy risk management, particularly in the competitive prime brokerage business. “There’s going to be a lot more questions about how they handled this situation,” Bair said. CS fired its chief risk office earlier this week, along with nearly half a dozen others.

These questions should chagrin senior Fed officials, especially Chairman Powell, who has repeatedly insisted that banks are much better capitalized now than they were in the run-up to the financial crisis, making a systemic blowup where over-leveraged hedge funds collapse like dominoes unlikely.

POWELL: FED SEES LITTLE RISK IN ARCHEGOS CAPITAL SITUATION SINCE ARCHEGOS CAPITAL RARELY HIRES EX-FED OFFICIALS TO GIVE SPEECHES

— Rudy Havenstein, CryptoPunk. (@RudyHavenstein) March 29, 2021

And Brown, for what it’s worth, will have an opportunity to interrogate Powell again in the not-too-distant future.