Near miss for JP Morgan and Citigroup on Archegos blow-up

IFR 2382 - 08 May 2021 - 14 May 2021
5 min read
Christopher Whittall

JP Morgan and Citigroup had both explored offering prime brokerage services to Archegos Capital Management prior to the firm’s spectacular collapse, according to several sources familiar with the matter.

The near miss for the US giants underlines how eager many of the world’s top investment banks had been to get a piece of the trading activity from Archegos, the family office of former hedge-fund manager Bill Hwang.

JP Morgan and Citigroup started examining Archegos as a potential prime brokerage client last year – after lobbying by the two banks' investment bankers – but progress was held up by so-called know-your-client processes demanded by risk and compliance departments, sources said, and Archegos blew up before those processes were complete. Both banks declined to comment.

As a result, neither bank had any exposure to Archegos when some of the fund’s highly-levered stock bets went wrong earlier this year, inflicting more than US$10bn of losses on a group of rival lenders. Credit Suisse, Morgan Stanley, Nomura and UBS were among the banks to sustain serious damage after helping Hwang’s firm use leverage to magnify bets on companies such as Viacom.

The scale of the losses have already surpassed those caused by Long-Term Capital Management, the infamous hedge fund that required a Federal Reserve-orchestrated bailout in 1998. Archegos is preparing to file for bankruptcy after banks attempted to recoup some of their losses, the Financial Times reported on Wednesday.

Prime expansion

Prime brokers are an important part of banks’ trading units, providing a gateway to financial markets for hedge funds and similar investors while also lending these clients money to help juice bets on stocks or other investments.

Many banks had looked to expand their network of prime brokerage clients in 2020 after business from quantitative-driven hedge funds – one of their main sources of revenue – looked set to decline. Those efforts to drum-up new business included targeting smaller and start-up hedge funds and family offices such as Archegos, sources said.

While less prominent than many well-known investment managers, family offices and smaller funds can still transact high volumes of business and so represent a meaningful source of income to banks' trading and financing desks. Industry experts estimated Archegos could have provided more than US$100m in annual revenues in total for its banks.

Hwang’s chequered past had proved a major sticking point for JP Morgan’s and Citigroup's risk and compliance departments when assessing Archegos as a potential prime brokerage client, sources said. In 2012, Hwang and the hedge funds he ran at the time paid a US$44m settlement after the US Securities and Exchange Commission charged him with insider trading.

Goldman Sachs, which counted Archegos as a prime brokerage client but avoided material losses from the firm’s failure, only started to work with the family office in late 2020 following years of bankers lobbying the compliance and risk department to allow it.

Levered losses

Some industry experts note investment banks such as Credit Suisse, Morgan Stanley and UBS have traditionally given a prominent focus to the wealth management business, which may have helped smooth the process for family offices like Archegos to become prime brokerage clients, particularly if they had existing wealth management relationships.

James Gorman, Morgan Stanley’s chief executive, said recently that the bank will be “looking hard at family office-type relationships where they're very concentrated and you have multiple prime brokers” after reporting US$911m of losses linked to Archegos.

But he also said “family offices are not bad” and advised against throwing “the baby out with the bathwater". Prime brokerage “is a gem of a business”, Gorman said, producing more than US$40bn for the bank in the past decade.

JP Morgan and Citigroup have large wealth management divisions and their investment banks are also active with family offices, though their trading divisions have historically tended to have a greater focus on institutional investors.

The scale of losses among banks that had active brokerage relationships with Archegos varied hugely. As well as the risk management decisions and the quality of the collateral they held, the amount of leverage banks offered Hwang’s firm was a pivotal factor.

Credit Suisse provided 10 times leverage on Archegos’s equity positions, reported, compared with four or five times provided by Goldman Sachs. Bankers at Goldman had grown concerned about the concentrated nature of Archegos's positions earlier this year before the family office ran into trouble and demanded more margin, sources said, giving the bank greater protection.

Credit Suisse was the worst casualty of the Archegos debacle, clocking up losses approaching US$5.5bn.

Banks that avoided the carnage reported strong equities trading results in the first quarter, with JP Morgan and Citigroup recording yearly revenue increases of 47% and 26% respectively. Goldman reported a 68% increase.

Archegos loss hits US$10.5bn

Adds bank responses to third paragraph