Credit Suisse Bet So Much on Archegos for So Little
(Bloomberg Opinion) -- A recurring theme in the gripping and extraordinarily detailed report about Credit Suisse Group AG’s $5.5 billion loss at the hands of Archegos Capital Management is how easily it could have been avoided.
Epic financial meltdowns are not a new phenomenon on Wall Street, of course. Long-Term Capital Management LP, Lehman Brothers Holdings Inc. and other firms populate a who’s-who list of fast-moving, elite money managers and brokers that courted disaster. Greed, shoddy management and weak risk controls are common culprits behind the nosedives.
Still, Credit Suisse is a reminder that some financiers have a limitless inability to learn from the past and an unquenchable desire to court wealthy clients capable of putting on a good show — regardless of the client’s track record. LTCM was undone when broad market movements turned against it. Lehman — and banks that subsequently got bailed out — took on colossal risks that bosses didn’t understand. Credit Suisse’s losses sprang from its faith in one man and his firm and from what the report describes as its singularly lackadaisical and reckless culture. A storied Swiss investment bank that had spent years overlooking red flags at Archegos was left with a gigantic loss that prompted emergency fundraising, a shattered reputation, layoffs and resignations, and an uncertain future clouded by the possibility of a takeover.
As the report by Paul, Weiss, Rifkind, Wharton & Garrison LLP, a law firm hired by the bank to examine the Archegos debacle, lays out, none of the hedge fund’s senior bankers at Credit Suisse seemed particularly alarmed when Archegos’s portfolio ballooned earlier this year. Junior bankers and risk managers who worked for the Zurich giant were agitated, as they had been for years, but their fears and warnings were routinely dismissed.
Even risk managers across different parts of Credit Suisse butted heads. On Feb. 9, a director monitoring hedge-fund hazards told the risk officers directly responsible for keeping tabs on Archegos that the fund needed to post $1 billion in fresh collateral after its trading positions triggered potential loss alerts. (All quotations in this column, unless otherwise identified, come from the Paul, Weiss report.)
But the lead risk manager on the Archegos account pushed back, disputing that the positions were perilous and emphasizing that he wanted to balance “a commercial outcome with risk management.” He also didn’t want “people up the chain” at Credit Suisse to think poorly of Archegos. Besides, the New York firm could easily liquidate its massive securities holdings “within a couple weeks.” Demanding $1 billion “is pretty much asking them to move their business, and the revenue profile is significant.”
A day later, Credit Suisse asked Archegos for $750 million. Archegos ignored the request, according to the report.
On Feb. 17, Credit Suisse’s monitors indicated that the firm’s exposure to potential Archegos losses had soared to $550 million. The next day, an analyst appealed to the lead risk manager on the Archegos account to quickly collect the $750 million from the high-rolling fund.
Archegos’s positions were backed by boatloads of debt, and the net asset value of its portfolio had ballooned from $1.5 billion to $8.1 billion in less than a year. The analyst warned that if Archegos stumbled, “all brokers [backing the hedge fund] would be looking to exit simultaneously.” His boss ignored him, noting that Archegos’s founder, Sung Kook “Bill” Hwang, had signaled that the firm would post more collateral. But Archegos pledged only an additional $34 million. Soon after that, Archegos told Credit Suisse that it had $6.6 billion in cash on hand should any troubles arise.
A special team of senior managers gathered at Credit Suisse on March 8 to scrutinize Archegos. Little came out of the meeting. Yet Archegos managed to extract payments totaling $2.4 billion from Credit Suisse between March 11 and March 19, even though it was ignoring the bank’s requests for tighter collateral calculations. The senior risk manager who had disregarded his underling’s warnings scheduled three collateral calls with Archegos between March 19 and March 23. Archegos backed out of each one at the last minute. During that period, Archegos’s hefty stakes in highfliers such as ViacomCBS Inc. suddenly began cratering.
On the morning of March 25, Credit Suisse asked Archegos to pay it more than $2.8 billion in a pair of margin calls. Archegos said it didn’t have the money — it had drained its cash reserves paying other brokers earlier in the week. During a conference call that evening, Archegos told all of its bankers that it had total exposure of about $120 billion but had only $9 billion to $10 billion in equity. It asked the group to give it time to sell its holdings. The bankers discussed a joint liquidation of the hedge fund, which Credit Suisse supported. But the banks went their separate ways. Archegos defaulted the next day, and it would take nearly a month for Credit Suisse to unwind its exposure.
A handful of senior Credit Suisse executives, including former chief risk officer Lara Warner, investment banking head Brian Chin, and Paul Galietto, who ran equities sales and trading, have departed since the implosion. Tidjane Thiam, who was the bank’s chief executive officer during the years when it ramped up its relationship with Archegos, left earlier during a corporate spying scandal. The bank is scrambling to rebuild its risk-management operations.
Credit Suisse lost far more money than any of the other banks exposed to Archegos, and that hit exceeded anything the firm seemed to have anticipated. While one of its analysts lauded Archegos because its “revenue profile” was “significant,” it actually wasn’t. Credit Suisse pulled in revenue of just $54 million from Archegos between 2017 and 2020, according to the report.
That was familiar math at Credit Suisse. When another hedge fund it backed, Malachite Capital Management, imploded last year, Credit Suisse lost about $214 million. It earned just $6.9 million in revenue from that six-year relationship.
So while fees or trading insights might have been Credit Suisse’s guiding lights in its transactions with Archegos, they don’t appear to have been lucrative enough to be the primary explanations for why the Swiss bank was so forgiving and scattered. It may boil down to culture, cost-cutting and ineptitude.
“Our key observations revolve around a central point: No one at CS — not the traders, not the in-business risk managers, not the senior business executives, not the credit risk analysts, and not the senior risk officers — appeared to fully appreciate the serious risks that Archegos’s portfolio posed to CS,” noted Paul, Weiss. “These risks were not hidden. They were in plain sight from at least September 2020. … The result was a business that allowed Archegos to take outsized risks without protecting CS from outsized losses.”
Money certainly incentivized Credit Suisse in its pursuit of Archegos’s business.
“At senior levels, the business had access to information showing that Archegos’s risks were mounting. This information was included in regular reports distributed to the business,” Paul, Weiss pointed out. “Yet the business either ignored these risks or lacked the competence to appreciate their significance; either way, reducing Archegos risk was not a priority. Instead, the business was focused on increasing Archegos’s revenues with CS, even at the expense of increasing the risk to CS far in excess of applicable limits.”
This included dismissing Hwang’s sketchy background.
Hwang was an alumnus of Julian Robertson’s old hedge fund, Tiger Management, and Robertson backed him when he started his own fund, Tiger Asia. Hwang subsequently pleaded guilty in 2012 to U.S. wire-fraud charges stemming from an insider-trading investigation. Hwang, his firm and others collectively paid penalties of $60 million to settle various criminal and civil charges. In 2014, Hong Kong regulators imposed a four-year trading ban on Hwang for insider-trading transgressions.
Tiger Asia returned cash to its clients and Hwang then rebranded his firm as Archegos, a so-called family office that managed personal funds without external investors.
Credit Suisse and others – including Nomura Holdings Inc., Morgan Stanley, and, eventually, Goldman Sachs Group Inc. — were happy to overlook Hwang’s past so they could play in his world. In 2012, two senior Credit Suisse executives told the firm that Hwang had told them at a breakfast that “he would be resolving his SEC action and accepting an industry ban, and that he would continue to face legal action in Hong Kong,” according to the report.
“The senior account manager further reported that Hwang would continue to manage $600 million of his personal net worth, that his performance was up as much as 20% for the year, and that the ‘bottom line’ is Hwang ‘still believes there are significant investment opportunities in Asia equities,’” the executives added. Hwang hoped “to be a significant account for CS in the years to come.’”
“There is no indication that any additional steps were taken … to scrutinize potential credit risk arising from either the conduct addressed in the settlement, guilty plea, or trading ban,” the report said.
It took three years for Credit Suisse to conduct a review of the reputational and legal risks Hwang posed. The individual responsible for covering Archegos spent months avoiding requests to do it, and only prepared it after being warned, mildly, that if he failed to do so Hwang’s account might be closed or Credit Suisse’s compliance department might send the banker a “letter of education.” Credit Suisse green-lighted Hwang after the report was written, observing that, despite his background, “Archegos had instituted ‘major changes … intended to make Archegos ‘best in class’ in terms of infrastructure and compliance as well as, of course, performance.’”
Credit Suisse’s subsequent reviews of Archegos were consistently riddled with conflicting appraisals. They characterized Archegos as having a “solid capital base,” “experienced management team,” “strong performance,” and “appropriate use of leverage,” yet also identified such crucial weaknesses as “key man reliance,” “volatile performance,” “poor risk management practices and procedures,” and “mediocre operational management practices/fraud risk.” There’s no indication in the Paul, Weiss report that those weaknesses prompted Credit Suisse to reassess its relationship with Archegos.
In 2018, after another assessment of Archegos’s reputational risk, U.S. and U.K. compliance executives at Credit Suisse recommended suspending the bank’s relationship with the firm. Yet they encountered “pushback from the business” and relented.
Archegos was handled by Credit Suisse’s “Prime Services” division, which looks after hedge funds and family offices. Its key offering is to provide financing that enables funds to control much larger blocks of securities than they could using just their own capital. As a lender to the fund, the bank is exposed to potential losses if their client’s investments fail. A key safeguard is requiring that the client puts up enough collateral to cover possible losses.
Although Hwang’s expertise in Asian markets was the draw, over time he invested heavily in U.S. securities and technology stocks. Credit Suisse never appeared to revisit whether his value to the firm and his expertise had changed after he shifted focus to new regions and sectors. In 2018, however, Archegos was placed on an internal watch list of risky funds. It remained on the list until it imploded earlier this year.
Credit Suisse was also patient with Archegos, despite its high volatility. In the first half of 2018, for example, it reported year-on-year gains of 41%. It finished the year down 36%.
It’s hard to tell how much of that registered with the bank. Management had been on a cost-cutting spree, and senior roles in the team overseeing Archegos were filled with less experienced bankers, resulting, the Paul, Weiss report noted, in “an overall decline in the level of relevant expertise.” From 2019 until Archegos’s default, about 40% of managing directors with risk-management roles left the bank, the report found. Nonetheless, Credit Suisse kept expanding Prime Services’ client list. “As a result, the significantly smaller Prime Services team struggled to handle more work with less resources and less experience,” the report found.
Credit Suisse set limits for its exposure to Archegos, based on analyses of what might happen in a stock-market crash. Yet it later repeatedly allowed Archegos’s exposure to bust through these ceilings. In May 2019, Archegos asked for better financing terms, arguing that rival investment banks were more competitive than Credit Suisse. The bank obliged.
The Covid-19 lockdown prevented traders and risk managers from interacting with one another personally, perhaps making oversight less effective. In early 2020, the risk manager overseeing Archegos died in a freak skiing accident. He was succeeded by Parshu Shah, a managing director from sales and marketing who had previously pitched business to Archegos — possibly compromising his independence in his new role.
Although he had been at Credit Suisse for 20 years, Shah had no experience there or elsewhere in risk management. He was “forced to learn on the job, primarily from more junior employees,” the Paul, Weiss report said. Like others at Credit Suisse, Shah isn’t identified by name in the Paul, Weiss report and no one at the bank has been accused of any wrongdoing.
The core risk-management team overseeing all of Credit Suisse’s hedge fund businesses was similarly hobbled. One person described the unit as forced to put out “flames with pales [sic] of water” and said it was often “playing catch up” in its supervisory work — not because they were “shirking their responsibilities, but because they did not have the resources to complete their work in a timely manner.”
After the Malachite fund defaulted in 2020 and saddled Credit Suisse with a sizable loss, the bank’s board ordered a review of what went wrong. It found that its bankers did not sufficiently heed “early warnings of potential distress” and that the bank’s “risk monitoring was inadequate.”
The same problems persisted with Archegos, despite the Malachite probe. Archegos regularly breached risk limits in 2020 and continued doing so until it collapsed. An effort to institute more rigorous collateral requirements last August was never implemented. In September, a risk analyst told his supervisor he worried that Prime Services wasn’t properly screening Archegos’s portfolio. The New York team responsible for doing so, he said, was not “adequately staffed to be reliable.”
“Where am I going with this? All of the people that I would trust to have a backbone and push back on a coverage person asking for zero margin on a heaping pile are gone,” the analyst complained. “The team is run by a salesperson.”
A special senior Credit Suisse committee reviewing Archegos’s risks last September set no deadline for changes that would have reined in the hedge fund and improved monitoring. Nor did it demand a follow-up meeting on the bank’s exposure to Archegos. One insider called those discussions “collegial,” with no sense of urgency.
“Margin” is Wall Street parlance for the cash counterparties are required to pledge for backing from banks such as Credit Suisse. The bank attempted to use a “dynamic margining” regime that would have involved more aggressive and granular oversight of Archegos’s trading, including more substantial collateral pledges from the fund. Software engineers modeling Archegos’s portfolio under dynamic margining guidelines about a month before it collapsed found that Archegos’s collateral account appeared to be underfunded by about $3 billion. But Credit Suisse never actually subjected Archegos to that model. It kept giving the fund more leeway and financial backing instead.
The lead risk manager on the Archegos account argued that forcing the fund to submit to dynamic margining guidelines would just confuse it. “Archegos would not want to deal with more than one initiative at a time,” he argued without explaining why it wasn’t urgent to examine the fund more rigorously.
More warning signs flared. Although Archegos had once estimated that its portfolio could be liquidated in a few days, it told Credit Suisse that it probably would take two weeks to a month to do so. Yet even as they downgraded Archegos’s creditworthiness, Credit Suisse managers sometimes recommended expanding the fund’s risk limits. Such contradictory, bumbling behavior continued almost up until the moment that Archegos collapsed.
Thomas Gottstein, who succeeded Thiam as Credit Suisse’s CEO, and Lara Warner, the bank’s risk and compliance chief, weren’t aware of how deeply the bank was exposed to Archegos until shortly before its liquidation — and neither knew the fund had been a top client, according to the Wall Street Journal.
What remains striking is that Archegos’s risks were flashing on everyone’s radar but kept being dismissed. Various risk committees discussed the fund but without any sense of the gravity of the situation. The persistent breaches of Credit Suisse’s own protocols never made it to the bank’s board for consideration. Even in early March, when the value of Archegos’s positions with Credit Suisse reached a whopping $21 billion, no one rang the alarm. (The investigation concluded that “this is not a situation where the business and risk personnel engaged in fraudulent or illegal conduct or acted with ill intent.”)
And why does this keep happening on Wall Street? LTCM was essentially the same problem — negligible collateral on enormous positions. Capital buffers were strengthened after the 2008 financial crisis, which was caused by banks amassing dodgy loans with no understanding of the risks they were taking on. The industry has become more aggressive about clawing back bonuses and other compensation after financial meltdowns, as has happened at Credit Suisse. None of this prevented the Archegos disaster.
Credit Suisse suffered the biggest hit, but there was pain to share. Nomura lost about $2.9 billion from the Archegos default, Morgan Stanley $1 billion, and UBS Group AG about $774 million. It’s not hard to see how situations like this could become seriously hazardous for the entire financial system. Losses of that magnitude also reflect how opaque Wall Street trading remains and how destructive it can become when it goes awry. The problem with investment banking being an oligopoly is that large risks can get concentrated in a handful of jumbo-sized, national players. Bankers and regulators still have work to do addressing these issues.
It’s tempting to say the investment banks should be forced to require hedge funds to hold prescribed levels of cash at a fixed proportion of their portfolios, but in reality, it’s hard to conceive of a one-size-fits-all regime that would cover every type of fund. And the fact is not all banks serving Archegos were badly burned. Goldman Sachs Group Inc., Wells Fargo & Co., and Deutsche Bank AG had minimal losses.
Archegos’s risk snowballed, as had LTCM’s, because it held parallel, concentrated positions with different investment banks. It isn’t clear what each bank understood about those positions or how much they were told by Archegos, an opacity that ultimately became disastrous. A central lesson is that an investment bank needs to know whether what it sees of a client’s position in a particular stock is just the tip of the iceberg.
The business of serving hedge funds is extremely profitable if done right. But it’s also competitive, which puts pressure on second-tier players like Credit Suisse to sacrifice safety in the headlong dash for growth. You have a valuable client, it has always made money, so you do what you can to keep it happy.
That’s why even technical fixes involving collateral requirements and portfolio sizes may never be bulletproof. For Credit Suisse, it was also more simple and human than that. Archegos had been in trouble with the authorities long before this year’s blowup, and common sense should have suggested wariness about the fund. Good managers know that talking about what might go wrong is pointless without accountability, deadlines and follow-ups.
Capitalism has a solution for firms that repeatedly go astray like Credit Suisse: a takeover. Archegos isn’t an isolated debacle for the bank. Its clients also had investments in funds it ran with Greensill Capital, a supply-chain finance business that collapsed recently, and Credit Suisse has had other horror shows going back years.
The bank must make an alluring target for crosstown rival UBS, valued by the stock market at $61 billion, more than twice as much as Credit Suisse. A combination would create a Swiss "national champion" with a huge list of wealthy clients and allow for constructive cost cuts.
You can see the temptation. Credit Suisse would secure its legacy inside a friendly Swiss institution, protecting it from a hostile Wall Street bidder. UBS would gain scale that would help it compete with U.S. behemoths that have prospered so much more than Europe’s investment banks since the financial crisis. But Switzerland should beware. Its regulators would have to supervise an even more complex firm, and its taxpayers would be left with an even bigger burden if there was another, deeper crisis.
Credit Suisse may stay independent. If it does, it probably won’t be because it deserves to but because no rival dares to take it on.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Timothy L. O'Brien is a senior columnist for Bloomberg Opinion.
Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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