Maybe the Next Archegos Won’t Be Such a Big Surprise
(Bloomberg Opinion) -- Back in March, an investment fund called Archegos Capital Management collapsed after building up vast derivatives bets on several stocks, precipitating billions of dollars in losses for its lenders. The incident raised a troubling question about the country’s financial early-warning system: How could regulators have remained unaware of such a large concentration of risk until it was too late?
Now the Securities and Exchange Commission has a plan to ensure that such dangers won’t go unnoticed. It should proceed as quickly as possible.
Recurring crises have prompted various efforts to make U.S. financial markets more transparent. Yet the results have been mixed, and many blind spots remain. Investors, for example, must publicly disclose stakes that exceed 5% of a public company’s equity — but this applies only to ownership of shares. If, by contrast, they employ derivatives to gain economic exposure, they can make bets far exceeding the 5% threshold without alerting anyone who has an adequate incentive to care about the systemic risks.
The Archegos episode, though not a systemic crisis in itself, vividly demonstrated the dangers. The fund gained tens of billions of dollars in exposure to companies including Discovery Inc., Tencent Holdings Ltd. and ViacomCBS Inc., with most of the funds borrowed from banks including Goldman Sachs Group Inc., Morgan Stanley and Credit Suisse Group AG. It achieved this in large part using derivatives such as total return swaps, in which the banks technically owned the shares. That meant Archegos didn’t have to inform regulators or file any public disclosures. An investigation commissioned by Credit Suisse into its $5.5 billion loss found that some of Archegos’s bankers were so concerned about losing a lucrative client that they failed to protect even their own institutions, let alone the broader financial system.
The SEC’s proposed solution is simple: Extend disclosure requirements to derivatives. Specifically, if an exposure is large enough — exceeding 5% of a company’s equity or a nominal dollar threshold — it must be publicly reported within one business day. Big exposures to a company’s debt must be reported, too. This will allow both regulators and the public to see such concentrations of risk as they build — and, if necessary, to put pressure on the relevant institutions to take precautions. It might also clarify the incentives of companies’ creditors, some of whom might have derivatives positions that would more than offset their potential losses in a bankruptcy.
To be sure, the proposal is just one step. Much more needs to be done to ensure that officials and the public have a reasonable grasp of what’s going on in markets, and to limit the leverage that can turn incidents like the Archegos implosion into larger disasters. But the perfect need not be the enemy of the good. Beyond any adjustments that may be needed to minimize burdens and make things work as smoothly as possible, the SEC should stick to its plan.
Editorials are written by the Bloomberg Opinion editorial board.
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