What does ‘Archegos’ mean to the FX industry?

There are many lessons to be learned in the aftermath of the Archegos meltdown. By now, the whole trading industry is aware of what happened.

Archegos defaulted on its margin loans when some highly concentrated bets went against the “family office”, leaving a number of investment banks holding the bag, with Credit Suisse and Nomura being the most exposed in the end.

The Securities and Exchange Commission, whose new Chairman was confirmed by the U.S. Senate this week, holds much of the blame. Crucial parts of the 2010 Dodd-Frank Act designed to temper excessive risk-taking in the derivatives market have been delayed forever.

These rules, if in force, would have required Archegos to disclose its derivatives trades, including the size of the orders and counterparts, and to post initial margin to cover potential trading losses.

Had they already done so, the SEC would have had access to data on Archegos’s trades, including the size of each transaction and who the family office had traded with — rules already established in other parts of the derivatives market regulated by the CFTC.

Equity total return swaps, used by Hwang’s Archegos, fall under the scope of the SEC and the new rules stemming from a 2010 Act are now due to come into force on November 1, 2021. The SEC took its time.

The Basel Committee on Banking Supervision and International Organization of Securities Commissions (Iosco) have defined the current global rules on margin requirements, but local regulators adapt them as they wish.

What does ‘Archegos’ mean to the FX industry?

Wider markets were insulated to the Archegos meltdown on account of updated capital rules post-2008, but such events still send shivers down the spine of many professionals within the FX industry.

FinanceFeeds spoke to executives at leading FX and CFD trading companies, including Advanced Markets, FXOpen, and ETX Capital, to better understand the impact of Archegos within the space.

“The scenario that is unfolding around Archegos is something that FX markets are very much familiar with, having experienced something similar several times in recent years”, said Natallia Hunik, Chief Revenue Officer at Advanced Markets, the FCA and ASIC-regulated provider of wholesale financial services for institutional clients.

“Just in the span of my career in the industry alone, I have witnessed a contraction in the FXPB sector, driven primarily by the volatile and high risk nature of the currency markets. FXPB, as it exists today, is not the same as it was a decade ago: the barrier to entry is much higher, with lower margins, increasing fees and a lot more compliance scrutiny.”

“It’s not surprising that following the SNB flash crash of 2015, that wiped out some major FX players and sent some into emergency funding, we are seeing similar scenarios occurring with Archegos and with Robinhood. It’s a big lesson on leverage that many FX players have yet to learn”, Ms. Hunik added.

“While tier one FXPBs have certainly tightened up their compliance requirements, and instilled risk-mitigating processes, the gap that has been left in the market by the exiting PBs has, in many cases, been filled by players who are not as compliance-vigilant and who have a much higher risk tolerance. In my opinion, if a similar problem were to arise in the FX market then that area would be the first place to look.”

Natalia Zakharova, Head of Business Development of FCA, CySEC, and ASIC-regulated retail FX and CFD broker FXOpen, believes the FX industry is much more risk-averse since the EUR/CHF flash crash in January 2015.

“I do not think that FX industry is that vulnerable to future mismanaged margin calls. Swiss Franc even back in 2015, although different to Archegos situation, changed the whole industry and made brokers much more risk averse.

“Many regulators have reviewed their policies on how brokers can handle client funds and introduced additional requirements. These days most regulated brokers used their own funds as a collateral for client positions leaving initial client deposits intact”, Ms. Zakharova continued.

“In Australia, for example, many brokers choose to segregate professional client funds, even when this is not required by ASIC. The regulators like FCA, who do not have these demands towards their licensees, offer government financial services compensation schemes for retail customers.

Andrew Saks, Head of Research and Analysis at ETX Capital, published an op-ed at FinanceFeeds about the issue.

“Now is the time to use the Archegos hedge fund incident as an example of how inept risk management from Tier 1 institutions can lead to problems of which certain areas of the FX industry which are completely unassociated with the banks that created the problem could have to bear the brunt”, Mr. Saks said.

Market crashes are usually followed by introspection and new rules and regulations to curb systematic risk from the market. There are many lessons to be learned in the aftermath of the Archegos meltdown. Most will probably go unlearned and others will be forgotten.