The Archegos FX fall-out: Who are the big losers? Make sure it is not you!
The following is a guest editorial courtesy of Andrew Saks, Head of Research and Analysis at ETX Capital.
£7 billion.
Let’s stop for a few minutes and think about that figure.
£7 billion.
The dismissive way in which this quite astonishing cumulative loss has been nonchalantly trotted out this morning as if it was of minor importance represents either a deliberate playing down of a self-inflicted catastrophe by some Tier 1 FX interbank dealers, or an absence of understanding the magnitude of the effect the risk management faux pas has had.
Way down in this week’s news lie very scant reports on the actual losses made by the banks which were involved in the ill-fated Archegos hedge fund, in a format which simply lists them as financial metrics.
There is, of course, far more to it than just figures on a balance sheet.
First of all, for Tier 1 FX interbank dealers with massive market dominance to make a combined £7 billion loss as a result of the demise of just one hedge fund is enough to make one’s teeth itch.
Secondly, how this occurred, when the firms now considering their losses are longstanding dominant forces in terms of FX market share who are constantly curtailing the extension of counterparty credit to very good quality OTC derivatives participants, should be a moot point.
Japanese investment bank Nomura which is one of the world’s largest Tier 1 FX interbank dealers which serves its own domestic market which is the largest retail FX market in the world with over 35% of retail FX order flow taking place within Japan’s borders via domestic market FX brokerages which often individually conduct over $1 trillion in notional volume each month, revealed a £2.1billion hit yesterday and suspended its head of prime brokerage, Dougal Brech.
UBS, one of the top ten in terms of interbank FX trading volume globally, also unveiled a £619million Archegos-related loss.
Credit Suisse has already admitted a £3.9billion hit, while Morgan Stanley lost £655million. Credit Suisse, which had once been among the top 5 interbank FX dealers worldwide until five years ago when it had plummeted to fourteenth position and made an operating loss of $2 billion, was on track for a profitable year until the Archegos hedge fund went to the wall, exposing the bank to a massive black hole.
Credit Suisse had demonstrated extremely good commercial conduct with regard to its interbank eFX business during loss making years in the middle of last decade, however other aspects of its corporate structure have been the subject of regulatory scrutiny and censuring which has cost the bank a fortune.
The settlement with US Department of Justice which totaled £4.3 billion for mis-selling mortgage-backed securities in the lead-up to the financial crisis had been a case in point to which CEO Tidjane Thiam began to concentrate even further on cost cutting.
Japanese lenders MUFG and Mizuho are expected to report that Archegos cost them around £280 million in the first three months of this year.
Archegos defaulted on its margin loans when some highly concentrated bets went against the “family office”, leaving a number of investment banks holding the bag. Before the full extent of the losses across the banking sector had been calculated, it was assumed that Credit Suisse and Nomura were the most affected.
Two weeks ago, I stated publicly that now is the time to use the Archegos hedge fund incident as an example of how inept risk management from Tier 1 institutions can lead to problems of which certain areas of the FX industry which are completely unassociated with the banks that created the problem could have to bear the brunt.
Subsequently, it is very important that traders in all areas of OTC derivatives including retail FX take a close look at how their brokerage conducts risk management, and whom their counterparty is.
It may well be good practice to look closely at quality companies in regions of the world that have strong regulatory frameworks and high levels of customer security should something go awry.
British FX and CFD brokers stand out in this respect, given that they own their own infrastructure, have their own in-house trading platforms meaning that they have invested significantly in providing the most structured and well developed trading experience for their clients rather than simply onboarding them as ‘leads’ and then placing them on an affiliate marketing-orientated third party platform over which the broker has no control.
Being a valued client of a company which has its own trading infrastructure immediately places traders in a much more empowered position. Companies that have their own trading platform are invested in their clients’ trading activities and will generally engage a good quality domestic market client base over a long period of time and serve them properly, rather than consider them expendable and have no ability to provide a good quality product range as is the case with brokers that use a generic off-the-shelf platform.
Additionally, clients of British brokers are automatically covered by the Financial Services Compensation Scheme, which backs customer funds up to £85,000 should a firm become insolvent. That is the highest level of protection in the world by far.
Why is this relevant?
Well, given the absent risk management by the banks which now stare down a collective hole of £7 billion whilst reporters and banking regulators look on haplessly, it is of paramount importance to ensure that traders do not put blind faith in these institutions which are clearly easily taken in by the ability to onboard a large fund regardless of risk, and yet curtail counterparty credit to the far more distributed and less risky FX market.
Operating a good quality in-house risk book is of imperative importance as one of the key considerations for traders.
Perhaps the questions that should be asked of brokers should be if the firm operates its own trading infrastructure, and if it operates a benevolent B-book, meaning that the company internalizes trades rather than sends them to a Tier 1 bank as counterparty whilst using genuine price feeds from a prime brokerage to ensure trades are executed at the correct market prices.
By providing correct market pricing and executing trades in house, customers are protected from situations such as this.
Brokers need to look toward diversifying their asset class base, being more masters of their own destiny by investing in the development of their own multi-asset platforms and being less reliant on Tier 1 bank counterparty credit. The same banks that demand over $50 million balance sheet proof before extending an OTC prime brokerage account to an OTC counterparty don’t use the same caution when they onboard hedge funds that can decimate them.
Credit Suisse, Nomura et al may well have their own capital position decimated by this rashness. By operating a shrewd in-house risk management strategy, having a competent proprietary platform and offering a multi-asset environment where traders can execute across venues in all parts of the capital markets economy is the way forward.
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Anonymous
April 28, 2021 @ 10:30 pm
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