Family Office

Hedge Funds That Morph Into Family Offices - The Archegos Fallout

Tom Burroughes, Group Editor, 1 April 2021

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The dramas put banks' risk management systems under scrutiny and also raise questions about whether hedge funds that morph into family office structures - thereby avoiding certain regulatory oversight - have been running more risk than a more conventional family office would ever tolerate.

The plight of US-based Archegos Capital Management, a hedge fund structured as a family office, raises questions about whether such entities should come under tighter regulatory oversight. Losses at the New York-based organisation have hit a raft of banks, notably Nomura and Credit Suisse.

The entity operates as a family office for former New York hedge fund executive Bill Hwang. Credit Suisse and Nomura have warned of potential large losses. Goldman Sachs, Morgan Stanley, Citigroup, BNP Paribas, Deutsche Bank and UBS are reportedly affected, to a lesser degree, media reports said. 

There has been a trend over the past 10 years of hedge fund firms morphing into family offices by ceasing to manage third-party funds - George Soros is an example. In July last year, John Paulson, who earned billions of dollars by correctly anticipating the sub-prime mortgage wreck of a decade ago, exited the business and converted his operation to a family office. Others taking the route are Leon Cooperman, Steven A Cohen, Eric Mindich and Jonathon Jacobson, although for different reasons. Another example is Clifton Robbins' switch at his Blue Harbour Group business.

As a result, these entities aren’t covered by the Securities and Exchange Commission, as would otherwise have been the case following the Dodd-Frank legislation enacted after the 2008 financial crash. 

These “hybrids” exist for various reasons besides avoiding SEC control. Poor investment performance or just a desire to wind down a business can be a factor, Alastair Graham, who founded and runs the Highworth Research database on single family offices, told this news service.

These “hybrid” entities aren’t typical family offices, which tend to be far less heavily leveraged than appears to be the case with Archegos, Graham said. “That [leverage] isn’t typical and they are usually the ones that are actually lending as private credit is an increasingly popular asset class for family offices,” he said. 

“Archegos is at the extreme end of the [leverage] spectrum,” Graham said. 

It is possible that the SEC and the US Treasury might press for more restrictions on the level of exposure that prime brokerages and hedge funds can have to avoid undue risk to the overall system, he said. 

The story also sheds light on whether, in a world of ultra-low interest rates and a hunger for yields, some banks’ risk controls may have been insufficient. 

This news service has contacted a number of law firms and hedge fund specialists about the case, and may update in due course. It also contacted the SEC for comment, which did not respond to requests for a comment by the time of going to press.

The saga has already prompted media speculation about the risk management systems at the affected banks. 

Policy moves since the market blow-up of 2008 may have built up more, not fewer, problems. A period of ultra-low interest rates and tighter capital requirements means that banks which are large enough to bear the risk have sought to bolster revenues by serving hedge funds. 

Hwang’s track record
Hwang, meanwhile, has a turbulent business history. He previously ran Tiger Asia Management LLC in 2001, a business based in New York, becoming one of the biggest Asia-focused hedge funds, running more than $5 billion at one point. In the summer of 2012, Tiger Asia said that it planned to wind down and return outside capital to investors. Later that year, the firm pleaded guilty to a criminal fraud charge and agreed to pay $44 million to settle civil allegations by US securities regulators that it engaged in insider trading of Chinese bank stocks. (Wall Street Journal, March 29.) “Tiger Asia regrets the actions for which it accepts responsibility today and is grateful that this matter is now resolved and behind it in the United States,” Hwang said in a statement at the time. The Tiger Asia business was rebranded as Archegos. 

At this stage, it is unclear whether central banks regard the issue as systemically important, as arguably was the case when hedge fund Long Term Capital Management imploded in 1998.

A report in the Financial Times (31 Marchl) said that Credit Suisse “still does not know how much it will lose from the Archegos sell-off,” although the publication said “early estimates” put the loss between $3 and $4 billion.

The FT said that Credit Suisse’s board is investigating which members of its executive team were chiefly responsible for the Greensill and Archegos crises. It said the bank has written down $450 million on its investment in hedge fund York Capital. It said that the bank’s clients could lose up to $3 billion from the frozen funds linked to collapsed specialist finance firm Greensill Capital, an amount equivalent to the lender’s entire net income last year. Meanwhile, Credit Suisse is being sued in London for its alleged role in bilking Mozambique’s taxpayers out of $200 million in the so-called “$2 billion tuna bond” scandal. The publication said the run of losses puts Thomas Gottstein, who has been CEO for more than a year, under pressure. 

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