Archegos, the Wall Street fire sale, and the need for reporting requirements

Family business and regulatory oversight

Salvatore Cantale, Professor of Finance at IMD 

The Archegos blow-up raises concerns over the regulatory oversight of family offices. They may be vulnerable to weak governance because those with fewer than 15 clients are excluded from even the most basic reporting requirements that larger hedge funds face. The US Securities and Exchange Commission lets family offices decide whether they want to register and open their books; Archegos discloses very little.

The waters were muddied by the complex financial derivatives that Archegos used to make trades that soured and spread across Wall Street. The instruments are called total return swaps, which allow investors to pay a fee for cash based on the performance of an asset. Swaps enable investors to amass stakes in companies without disclosing their holdings, especially if they are held with multiple banks, raising questions about risk management.

The Archegos saga underscores the need for tougher reporting requirements — to improve transparency and prevent financial contagion in wider markets. It’s unclear to what extent prime brokers knew about their own exposure to Archegos, because it magnified its position by holding swaps with several banks. But I suspect that if the banks were aware how leveraged the fund was getting they would have not extended credit with such high leverage ratios. The story is likely to draw the ire of regulators, but it is the responsibility of the board to evaluate a bank’s risk management procedures. It is clear that boards need to strengthen governance practices by improving lines of communication with the executive committee. The buck stops with the board.