Analysis: Credit Suisse's Risk Management Failure with Archegos

One of the most intriguing stories in the financial services industry over the past year involves the fallout with Swiss investment bank Credit Suisse. With back-to-back blows with Greensill and Archegos, with the latter being a $5.5 billion loss, top shareholders in the Swiss bank have expressed lack of trust in the board, particularly those on the bank’s risk committee. Andreas Gottschling, chairman of Credit Suisse’s risk committee, has faced increased opposition from shareholders from reelection. For many, he bears ultimate responsibility for the risk overexposure that resulted in the both catastrophic failures. Archegos, a U.S. family investment firm of former Tiger Asia manager Bill Hwang, took a series of bets on a few stocks on money loaned from banks. When a few of the positions reversed, it triggered margin calls that Archegos couldn’t meet. In that sudden turn of events, one of the largest losses in Wall Street history occurred.

The fallout with Archegos begs the question: how did banks approve of the lending to an investment firm with such a concentrated risk portfolio? The decision to fund Archegos is reminiscent of the 2008 financial crisis, where the pursuit of outsized gains led to predatory lending and incredibly risky mortgage backed securities. While Archegos’s full send on a few stocks may have sounded irrational, their decision to invest in a few select stocks almost entirely on borrowed money is not unheard of. At first thought, I can draw parallels between Michael Burry’s Scion Asset Management and Archegos. Burry’s conviction that the housing market was bound to fail was as strong of a conviction that Archegos held in those select stocks, if not even more outlandish. Prior to the 2008 financial crisis, a market crash as large as the one needed to trigger profit for Burry’s bet against subprime mortgages had never occurred. However, one significant difference between Burry and Hwang’s bets is that Burry held executive control of the funds held within Scion capital. Thus, he was able to freeze investors from pulling out money from the fund, whereas Archegos could not. This is reflected by what occurred: Burry for the first year leading up to the impending housing crisis was paying out millions in premiums. On the other hand, Hwang’s risky trades on leveraged credit resulted instantly triggered margin calls when things went south. My takeaway from Archegos’s collapse is that overextending on borrowed funds is simply too risky. It’s better to aim for outsized gains with money actually held by the firm, and being more conservative on bets with leveraged credit.

At the end of the day, Credit Suisse holds the responsibility for making the risky loan. After all, it was the investment banks like Lehman Brothers and Bear Stearns that went bankrupt when the borrowers of their subprime mortgages defaulted. It becomes quite troubling to hear that Credit Suisse’s Chief Executive and and Chief Risk Officer only became aware of the Archegos risk exposure just a few days prior to when the fund was forced to liquidate. The apparent reason behind the late notification was that Credit Suisse hadn’t yet implemented a new system that monitored how much risk a position changed as the prices of the securities held changed. The system, called dynamic margining, was not yet fully institutionalized in the division that oversaw Archegos. This lack of oversight by Credit Suisse is ridiculous. Considering their exposure was around $20 billion with Archegos, it is surprising that they escaped with about $5 billion lost with how late they pulled out. The strong overhaul of Credit Suisse’s risk management and lending practices will be crucial to ensuring the firm’s long term success. Just like how Lehman went bankrupt after being too risky, the failures of Archegos and Greensill will be a huge reckoning with how Credit Suisse approaches risk heavy lending in the future.