• Parth Goyal

Credit Suisse Lost $5.5 billion due to Arhegos

You might think there was some fraud here, you know the usual: un- dermining some risk somewhere to fill their pockets and it backfires in the same old wall street fashion. But,as much as I would love to tell you that’s the case, it isn’t. The risk was correctly assessed, reasonable col- lateral was set... only issue was that someone, somewhere, was too afraid to upset a client. Yup, that’s all it was. A critical thing investment banks do is loan money to hedge funds so that they can buy stock. Of course, this is risky: if the stocks go down, then the hedge fund is at risk for defaulting, so an important manage- ment question is whether the hedge fund has posted enough collateral. What then really is the right amount of collateral? Unfortunately, this is sometimes an obscure and vague question for investment banks. Hence they tend to break it down to more minor aspects: How much can the stock go down worst-case scenario? How quickly can well sell them? How much further down will that lead the stock? Look at historical numbers about volatility and correlation, compare the position size to stock’s daily volume, run formulas, etc. After doing your due diligence, you can call up your hedge fund to post more collateral, and they say, “I’m busy let’s talk tomorrow”, and you call them tomorrow. They say, “Hey, this week got away from me but send me an email,” and email them summarizing your collateral demand and call them next week. They say, “oh, I haven’t had a chance to look at your email yet, but I will very soon,” and meanwhile, the right amount of collateral keeps ticking up ... what do you do about that? In theory, if your client doesn’t post collateral, you would terminate the swap, but of course, what if they are swamped? It can’t hurt to talk to- morrow, right? And on top of that, if you swap, you lose their business, and the whole point of investment banking is to drum up more business. Here is you have an enormous paragraph detailing how it panned out from Matt Levine’s Money Stuff: On February 19, 2021, the PSR an- alyst sent a dynamic margining pro- posal to the Head of PSR for internal review, noting that he had made the terms “about as tight” as possible, yielding an average margin of 16.74% if applied to Archegos’s existing swaps portfolio and leading to a day- one step up of approximately $1.27 billion in additional margin. This was less than half of the additional initial margin that would have been re- quired if Archegos’s Prime Brokerage dynamic margining rules were ap- plied to Archegos’s swaps portfolio. On February 23, 2021, the PSR ana- lyst covering Archegos reached out to Archegos’s Accounting Manager and asked to speak about dynamic margining. Archegos’s Accounting Manager said he would not have time that day but could speak the next day. The following day, he again put off the discussion but agreed to review the proposed framework, which PSR sent over that day. Archegos did not respond to the proposal and, a week-and-a-half later, on March 4, 2021, the PSR analyst followed up to ask whether Archegos “had any thoughts on the proposal.” His con- tact at Archegos said he “hadn’t had a chance to take a look yet,” but was hoping to look “today or tomorrow.” As you can see after the first few sentences of technical details, it really was “the Client is busy and then what?” Well, and then what is that a few weeks later, the stock Archegos Capital owned went down the drain, and consequently “as a surprise” they didn’t have enough money to repay the loan to Credit Suisse. And from all this, Credit Suisse be- came a “measly” $5.5 billion poorer. It remains to see what fruit Credit Suisse’s legal suit and fir- ing a bunch of “incompetent MDs” (Credit Suisse says its MDs were incompetent | eFinancialCareers) will bear for them, but for next time, please don’t risk $5.5 billion just because you are scared to say no.

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