The Archegos Story – What FX Brokers Can Learn From It?

By Anya Aratovskaya From Advanced Markets

A well-educated Wall Street professional who started a career at a traditional financial corporation, networked, moved on to launch their own hedge fund, made mistakes (insider trading), paid fines to the SEC (44mln) in 2012, banned by MMT from trading in HK for 4 years in 2014 (insider trading), and restarted afresh with a new company (Family Office) that didn’t have the limitations of the previous company (contrary to a hedge fund, family offices are not required to register with the Securities and Exchange Commission and file regular reports). Not to mention, founded and run a charitable organization that reported almost $500 mln in assets on 2018 tax forms.

Industry experience and connections (as well as promises of trading volume and decent capital) will open many doors, and in a matter of a few years, Archegos was able to secure Prime Broker relationships with top-tiered PBs (Nomura, Credit Suisse, Goldman Sachs, Morgan Stanley).

Prime Brokerage Services include actual “physical”, or cash, financing (loans, for example) and “synthetic” financing (leveraged trading in FX terms). Qualified financial institutions (Hedge Funds, Prime of Primes, Family offices) borrow money from Prime Brokerages to place leveraged orders. The amount of leverage given is determined, exclusively, based on the client profile (background, trading style, capital etc.).

Leverage has always been a hot topic for the Prime Brokers as cases such as Archegos (overleveraged clients losing more capital than they have) had arisen before. In March of 2020, ABN Amro Clearing (Prime Brokerage arm of Dutch bank ABN Amro) reported a $200 million loss when one US hedge fund went into margin call; in 2018, Citi restructured their entire Prime Brokerage unit and closed a few dozen FX Broker and Fund PB accounts due to a $180 million loss on currency trades by an Asian fund.

Leveraged financing, with proper risk management, is a profitable business for the banks but can often bring the risk of large swings in revenue. Some experts suggest that leveraged financing won over 50% of all prime brokerage business in 2020 due to the pandemic-related capital inflows so, most likely, the industry can expect to hear of similar stories.

The Archegos case, and the losses that it caused for the banks, apparently was not significant enough to cause a “Lehman event”, however, here are the most likely changes in the Prime Brokerage side of the business that could occur as a result:

1. Regulators in Europe, and the U.S., are looking for ways to bring transparency and to regulate trading disclosures from hedge funds and family offices (in the U.S. family offices have reporting exemptions)
2. Prime Brokers will implement more restrictive terms for leveraged clients
3. Nomura and Credit Suisse have already started Prime Brokerage business restructuring (will they close some of their PB accounts?)
4. An overall Increase in compliance scrutiny for new, and existing accounts of Prime Brokerages (and particularly Family Offices)
5. Possible new regulations related to Swaps centralization

As often happens, time will tell the actual measures as banks try to fix structural gaps in their Prime Brokerage business and protect their own reputation more than anything else. And for FX brokers, maybe it’s time to re-evaluate the risk, earning and approach in trading leveraged products: read this article examining Negative Balance Production and leveraged products in detail and learn how to mitigate your risk whether you are retail FX clients or professional traders.

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Anya has over 10 years of financial services industry experience. She has developed a broad knowledge in all aspects of the Foreign Exchange business environment, latest technological capabilities, risk management and global regulatory practices. Anya is a specialist in the dynamic Eastern European FX market. She has helped numerous FX companies, banks and asset managers elevate their businesses to a completely new level by successfully implementing progressive technologies and liquidity solutions into their models. She provides valuable leadership and direction to the company’s staff and outside counsel. Anya holds a Master of Science degree in Financial Services from Northeastern University.