The recent losses caused by Archegos Capital Management on Wall Street have shone what may be an unwelcome spotlight on the regulation of family offices. This has led to concerns, particularly in the United States, that new disclosure requirements may now be imposed on family offices.
The issue has been highlighted by the $10 billion losses caused to a number of major banks as a result of providing prime brokerage finance to Archegos to invest in the stock market.
What caused the most consternation in the markets is the fact that these losses arose in the traditionally conservative areas of prime brokerage and family offices. Since prime brokers only deal with other financial institutions and family offices do not manage outside investors’ money, they have been deemed to be less likely to cause risk to retail investors and have therefore been given a lower risk profile. As a result, both prime brokers and family offices have been subject to less strict regulatory control. That lack of regulatory scrutiny may have contributed to the risks to which Archegos and its prime brokers were willing to expose themselves.
For Archegos’ trades which the banks were funding were anything but low risk. For a start, Archego was owned by Bill Hwang who had a well-publicised chequered career—he had been convicted of wire fraud in 2012 and subsequently banned from trading in Hong Kong. That should have immediately raised red flags among the banks’ risk managers.
Second, although Archegos did not have the resources to buy vast amounts of equities outright, the banks had agreed to enter into total return swaps which allowed Archegos to take synthetic positions in equities. These positions were highly leveraged and have been estimated at a total exposure of $50 billion; this meant that Archegos was highly exposed to volatility in the stock markets.
The risks were further increased by the fact that the stocks it invested in were highly concentrated on a small number US media and Chinese tech companies so once Archegos’ positions in ViacomCBS suffered a severe downturn, it did not have the resources to pay the banks’ margin calls and that in turn forced the banks to rapidly unwind their own positions which resulted in a loss to them estimated at $10 billion.
These kinds of trade are more associated with aggressive hedge funds, but since Archegos qualified as a family office, those risks did not have to be disclosed in the same way and that may have led banks not to appreciate that Archegos’ exposure was so large or that it was spread across so many banks at once.
What happened to Archegos has alerted US regulators to the fact that family offices are a potential source of systemic risk in the markets. Until now, they have been exempt from having to register and disclose their activities even after the introduction of the Dodd-Frank Act, but following its collapse, both the Securities and Exchange Commission and the Commodity Futures Trading Commission have made noises about increasing the level of transparency for family offices, particularly when it comes to trading in derivatives.
With a total of $6 trillion under management, family offices are effectively twice the size of the hedge funds industry. With that scale of investment, there is obviously a concern that if there is a trend towards family offices entering into more risk-taking activities, and if those activities are less than transparent, that could have serious repercussions for the financial markets as a whole. That may mean regulators will be paying more attention to the activities of family offices in general in the future and potentially seeking new powers against them.