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How the Quest for Huge Returns by Financial Institutions Trumps Prudent Risk Management: The Archegos Saga

Received: 20 March 2022     Accepted: 13 April 2022     Published: 25 April 2022
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Abstract

Competition in the financial services sector has always been fierce. In many respects financial services is a sophisticated borrower’s market. Sophisticated borrowers with a proven track record are able to mobilise significant amounts of financial resources as they pursue complex and innovative financial strategies which are regarded by the various lenders as so likely to be profitable, that the risk is worth taking. The risk is attached to a specific instrument, real or synthetic such as a total return swap, and is a bet on the direction of the value of the instrument. In the quest for business, especially “aggressive deal makers” like Bill Hwang of Archegos, securities financing institutions can and do compromise their own due diligence and risk management processes and procedures. Often, tension arises within firms when the dealmakers pushing hard to take on business come up against resistance from cautious risk managers. In a profit driven industry, risk managers are often overruled by management, in favour of deal makers. This case had an impact across borders. When the implosion eventually occurred securities financing firms were shown to have disregarded prudent risk management practices. The failure of Archegos compelled regulators to act in order to prevent similar possibly worse collapses in the future. Remedial measures included a direction to securities financing institutions to demonstrate a commitment to safe practices by adopting a risk based approach to their supervisory activities. The failure of Archegos highlights the importance of an understanding of the key inherent risks faced by entities offering equity financing transactions, and also the supervisor’s expectation for the mitigation of these risks. In the operational sphere, it is evident that risk mitigation can be enhanced by a clear demarcation and understanding of the roles of the first line of defense, second line of defense, senior management and the board.

Published in International Journal of Economics, Finance and Management Sciences (Volume 10, Issue 2)
DOI 10.11648/j.ijefm.20221002.14
Page(s) 67-72
Creative Commons

This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution and reproduction in any medium or format, provided the original work is properly cited.

Copyright

Copyright © The Author(s), 2022. Published by Science Publishing Group

Keywords

Competition, Due Diligence, Inherent Risks, Risk Management, Risk Based Supervision, Lines of Defense, Governance of Business, Market Conduct

References
[1] George Santoyama “The Life of Reason”, 1905. https://americanart.si.edu/artwork/those-who-cannot-remember-past-are-condemned-repeat-it-george-santayana-life-reason-1905 (last visited 12 April 2022).
[2] Nathaniel Benjamin, David Bailey and Sarah Pritchard, Joint Letter (bank of England and Financial Conduct Authority) to banks operating in the UK: “Supervisory review of global equity finance businesses, default of Archegos Capital Management”. December 2021 https://www.bankofengland.co.uk/prudential-regulation/publication/2021/december/supervisory-review-global-equity-finance-businesses (last visited 12 April 2022).
[3] Siddharth Prabhu, Duke University Durham, NC May, 2001: “Long-Term Capital Management, the Dangers of Leverage.” https://sites.duke.edu/djepapers/files/2016/08/prabhu.pdf (last visited 12 April 2022).
[4] Janet Tavakoli: “Introduction to Total Return Swaps.” https://www.tavakolistructuredfinance.com/trs/ (last visited 12 april 2022).
[5] Prachi Juneja: “Prime brokers in investment banking” https://www.managementstudyguide.com/prime-brokers-in-investment-banking.htm (Last visited 12 April 2022).
[6] Conrad Montford: “Family office type investment management services for trustees and high net worth investors.” February 2004. https://academic.oup.com/tandt/article/10/3/27/1625717 (last visited 12 April 2022).
[7] Tabby Kinder and Leo Lewis: “How Bill Hwang got back into banks’ good books — then blew them up.” March 2021. https://www.ft.com/content/b7e0f57b-3751-42b8-8a17-eb7749f4dbc8 (last visited 12 April 2022).
[8] Lara Noonen: “Bank of England orders review in wake of Archegos scandal.” December 2021. https://www.ft.com/content/b351691a-2ffd-45a6-8753-7a9a547853ef (last visited 12 April 2022).
[9] Leo Lewis and Owen Walker. “Total Losses from Archegos Bank Implosion exceed $10 billion”. 27 April 2021. https://www.ft.com/content/c480d5c0-ccf7-41de-8f56-03686a4556b6
[10] Tony Randle, World Bank: “Risk based supervision”– December 2009 https://openknowledge.worldbank.org/bitstream/handle/10986/27499/625140NWP0Risk00Box0361486B0PUBLIC0.pdf?sequence=1 (last visited 12 April 2022).
[11] Alliance for Financial Inclusion: “Market Conduct Supervision of Financial Services Providers”, August 2016. https://www.afi-global.org/wp-content/uploads/publications/2016-08/Guideline%20Note-21%20CEMC-RiskBased.pdf (last visited 12 April 2022).
[12] Stephen Po: “Market Intermediaries Risk Based Supervision – IOSCO”. September 2014 https://www.iosco.org/library/annual_conferences/pdf/39/Stephen-Po-RBS.pdf (last visited 112 April 2022).
[13] Sam Woods, Bank of England: “Prudential Regulatory Authority – PRA Approach to Banking Supervision – Banking and Insurance - Bank of England - Prudential Regulatory Authority – PRA Approach to Supervision – Banking and Insurance. October 2018 - http://www.bankofengland.co.uk/publications/Pages/other/pra/supervisoryapproach.aspx
[14] Stephen Zamore, Kwame Djan, Ilan Alon and Bersant Hubdari, University of Agder Gimlemoen, Norway: “Credit Risk Research and Agenda”. 2018. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3126366 (Last visited 12 April 2022).
[15] Abdullah Aloqab: “Operational Risk Management in Financial Institutions: An Overview.” 2018. https://www.academia.edu/38676953/Operational_Risk_Management_in_Financial_Institutions_An_Overview. (Last visited 12 April 2022).
Cite This Article
  • APA Style

    C. King Chanetsa. (2022). How the Quest for Huge Returns by Financial Institutions Trumps Prudent Risk Management: The Archegos Saga. International Journal of Economics, Finance and Management Sciences, 10(2), 67-72. https://doi.org/10.11648/j.ijefm.20221002.14

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    ACS Style

    C. King Chanetsa. How the Quest for Huge Returns by Financial Institutions Trumps Prudent Risk Management: The Archegos Saga. Int. J. Econ. Finance Manag. Sci. 2022, 10(2), 67-72. doi: 10.11648/j.ijefm.20221002.14

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    AMA Style

    C. King Chanetsa. How the Quest for Huge Returns by Financial Institutions Trumps Prudent Risk Management: The Archegos Saga. Int J Econ Finance Manag Sci. 2022;10(2):67-72. doi: 10.11648/j.ijefm.20221002.14

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  • @article{10.11648/j.ijefm.20221002.14,
      author = {C. King Chanetsa},
      title = {How the Quest for Huge Returns by Financial Institutions Trumps Prudent Risk Management: The Archegos Saga},
      journal = {International Journal of Economics, Finance and Management Sciences},
      volume = {10},
      number = {2},
      pages = {67-72},
      doi = {10.11648/j.ijefm.20221002.14},
      url = {https://doi.org/10.11648/j.ijefm.20221002.14},
      eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.ijefm.20221002.14},
      abstract = {Competition in the financial services sector has always been fierce. In many respects financial services is a sophisticated borrower’s market. Sophisticated borrowers with a proven track record are able to mobilise significant amounts of financial resources as they pursue complex and innovative financial strategies which are regarded by the various lenders as so likely to be profitable, that the risk is worth taking. The risk is attached to a specific instrument, real or synthetic such as a total return swap, and is a bet on the direction of the value of the instrument. In the quest for business, especially “aggressive deal makers” like Bill Hwang of Archegos, securities financing institutions can and do compromise their own due diligence and risk management processes and procedures. Often, tension arises within firms when the dealmakers pushing hard to take on business come up against resistance from cautious risk managers. In a profit driven industry, risk managers are often overruled by management, in favour of deal makers. This case had an impact across borders. When the implosion eventually occurred securities financing firms were shown to have disregarded prudent risk management practices. The failure of Archegos compelled regulators to act in order to prevent similar possibly worse collapses in the future. Remedial measures included a direction to securities financing institutions to demonstrate a commitment to safe practices by adopting a risk based approach to their supervisory activities. The failure of Archegos highlights the importance of an understanding of the key inherent risks faced by entities offering equity financing transactions, and also the supervisor’s expectation for the mitigation of these risks. In the operational sphere, it is evident that risk mitigation can be enhanced by a clear demarcation and understanding of the roles of the first line of defense, second line of defense, senior management and the board.},
     year = {2022}
    }
    

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  • TY  - JOUR
    T1  - How the Quest for Huge Returns by Financial Institutions Trumps Prudent Risk Management: The Archegos Saga
    AU  - C. King Chanetsa
    Y1  - 2022/04/25
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    AB  - Competition in the financial services sector has always been fierce. In many respects financial services is a sophisticated borrower’s market. Sophisticated borrowers with a proven track record are able to mobilise significant amounts of financial resources as they pursue complex and innovative financial strategies which are regarded by the various lenders as so likely to be profitable, that the risk is worth taking. The risk is attached to a specific instrument, real or synthetic such as a total return swap, and is a bet on the direction of the value of the instrument. In the quest for business, especially “aggressive deal makers” like Bill Hwang of Archegos, securities financing institutions can and do compromise their own due diligence and risk management processes and procedures. Often, tension arises within firms when the dealmakers pushing hard to take on business come up against resistance from cautious risk managers. In a profit driven industry, risk managers are often overruled by management, in favour of deal makers. This case had an impact across borders. When the implosion eventually occurred securities financing firms were shown to have disregarded prudent risk management practices. The failure of Archegos compelled regulators to act in order to prevent similar possibly worse collapses in the future. Remedial measures included a direction to securities financing institutions to demonstrate a commitment to safe practices by adopting a risk based approach to their supervisory activities. The failure of Archegos highlights the importance of an understanding of the key inherent risks faced by entities offering equity financing transactions, and also the supervisor’s expectation for the mitigation of these risks. In the operational sphere, it is evident that risk mitigation can be enhanced by a clear demarcation and understanding of the roles of the first line of defense, second line of defense, senior management and the board.
    VL  - 10
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Author Information
  • Centre of Excellence in Financial Services, Johannesburg, South Africa

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