4/13/2021 US put off derivatives rules for a decade before Archegos blew up | Financial Times

US financial regulation
US put off derivatives rules for a decade before Archegos blew up
Regulation of swaps used by Bill Hwang was pushed back once again by Covid

Margin requirements for smaller financial firms using swaps, such as Bill Hwang’s Archegos Capital, had been due to go into force
last year © Financial Times

Joe Rennison, Eric Platt, Colby Smith and Philip Stafford YESTERDAY

Rules written in the aftermath of the 2008 financial crisis to limit the potential for a
blow-up like Archegos Capital have still not been fully implemented, throwing a
spotlight on regulators in a fiasco that has shocked Wall Street and raised questions
on Capitol Hill.

Crucial parts of the 2010 Dodd-Frank Act, an 848-page law that was meant to shore
up big banks and temper excessive risk taking in the derivatives market, have been
delayed again and again.

Critics are now arguing that had regulators implemented the rules faster, the
implosion of Bill Hwang’s family office and the multibillion-dollar losses it caused two
banks could have been limited.

In particular, rules that would have governed the disclosure of Archegos’s derivatives
trades are still not in force, and neither are requirements for players like Hwang to
post initial margin, payments meant to cover potential trading losses. Hwang was able
to place more than $50bn of bets on the share prices of a handful of US and Chinese
companies, and could not pay his counterparties when they started going against him.

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4/13/2021 US put off derivatives rules for a decade before Archegos blew up | Financial Times

Diane Jaffee, a portfolio manager at asset manager TCW, said that regulators had
implemented Dodd-Frank at an “anaemic” pace. The ability of an unknown family
office like Archegos to run up such outsize risks “is like the last hurrah . . . before
regulations come in,” she said.

Equity total return swaps like those used by

Archegos are overseen by the Securities and
What we try to do is Exchange Commission, which has been far
make sure that the slower to write its rules than the Commodity
banks understand the Futures Trading Commission, the main
risks that they're derivatives regulator.
running and have
SEC rules are due to finally come into force
systems in place to on November 1. Had they already done so,
manage them. This the SEC would have had access to data on
would appear to be . . . a Archegos’s trades, including the size of each
failure on that front transaction and who the family office had
traded with — rules already established in
Jay Powell, Federal Reserve chair
other parts of the derivatives market
regulated by the CFTC.

“It is a dereliction of duty by the SEC not to have a properly regulated swaps market
13 years after they were at the core of causing and spreading the 2008 crash,” said
Dennis Kelleher, president of the advocacy group Better Markets.

The opacity of Archegos’s positions has proven central to the incident, given many of
its trading counterparties did not know it had taken similar positions with other banks
across Wall Street. It was only when Hwang called Archegos’ many counterparties
together for a meeting in late March that it became clear to each bank how large and
concentrated the Archegos positions were, people familiar with the meeting have said.

“The SEC is 10 years late on implementing rules that would have provided more
transparency into what was happening,” said an executive focused on government
regulation at a large hedge fund. “The SEC completely dropped the ball.”

The SEC declined to comment.

Margin requirements were delayed

The SEC has also not implemented rules on margin requirements for derivatives
trades conducted away from exchanges and clearing houses, which would affect the
broker dealers it regulates.
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4/13/2021 US put off derivatives rules for a decade before Archegos blew up | Financial Times

Broad global rules demanding that asset managers set aside more cash to cover their
swaps deals are defined by the Basel Committee on Banking Supervision and
International Organization of Securities Commissions (Iosco), the umbrella group for
global markets watchdogs. Local regulators are given some leeway to adapt the rules
to their markets.

In the US, that job is split among a host of regulators. Federal banking regulators have
already introduced margin requirements for large banks trading with each other.
However, as Covid-19 struck last year, global regulators agreed to push back the
implementation of the rules that covered smaller financial firms trading derivatives
from September 2020 to September 2022.

That decision meant a group like Archegos — which held derivatives positions worth
more than $50bn, according to people familiar with the trades — was not required by
any US regulators to post margin when it first initiated a trade.

Had the delay not been agreed, Archegos would have likely tripped above the
designated size threshold last September, requiring it to post margin by Basel and
Iosco standards after the value of its notional derivatives exposure eclipsed $8bn. The
rules would require enough cash to cover 10 days of possible losses, based on the
historic performance of the shares.

“The rules were designed to deal with these risks but they were designed on a schedule
that ends up being too late to catch this counterparty,” said a derivatives lawyer at a
large international law firm.

Wider markets were insulated

Multiple derivatives lawyers noted that post-financial crisis capital rules had helped
insulate wider markets, with some of the banks involved absorbing sizeable losses
without the need for state intervention.

Credit Suisse suffered a $4.7bn loss, while Nomura has warned it could lose $2bn.
Others, including Morgan Stanley, Goldman Sachs and Wells Fargo, collectively sold
more than $20bn worth of stock they held as hedges for their trades with Archegos to
limit their own losses. So far, nine banks have found themselves involved in the
tumult, including Deutsche Bank, UBS, Mitsubishi UFJ Financial Group and Mizuho.

The banks’ prime brokerage units that enabled Archegos’s supercharged trades have
not disclosed how much margin they required when the fund first initiated its
transactions. Lawyers who work with banks said they have not typically implemented
regulatory minimums before they come into force, because of competitive pressures.
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4/13/2021 US put off derivatives rules for a decade before Archegos blew up | Financial Times

Federal Reserve chair Jay Powell signalled concern, telling the CBS news programme
60 Minutes on Sunday that he was concerned trades with a single customer could
result in such substantial losses to these large firms.

“What we try to do is make sure that the banks understand the risks that they're
running and have systems in place to manage them,” he said. “This would appear to
be a significant shortfall — a failure on that front.”

Credit Suisse, Deutsche Bank, Goldman, MUFG, Mizuho, Morgan Stanley, Nomura,
UBS and Wells Fargo declined to comment, as did Archegos.

Copyright The Financial Times Limited 2021. All rights reserved.

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