A mysterious selloff late last week caused a significant decline in Wall Street’s main indexes on Monday, as several major global banks revealed they faced potential losses to the tune of billions of dollars after a hedge fund defaulted on its margin calls.
Last Friday, Morgan Stanley, Goldman Sachs Group Inc., and Deutsche Bank AG quickly sold nearly $30 billion worth of shares in numerous US media and Chinese tech companies, leaving traders wondering what sparked the massive selloff. It later turned out the selling pressure was linked to the forced liquidation of positions held by billionaire Bill Hwang’s US hedge fund Archegos Capital, after it defaulted on its margin calls.
A large portion of Archego’s leverage was in the form of contracts-for-difference, provided by several prominent banks including Nomura Holdings Inc and Credit Suisse Group AG— both of which have now admitted extensive losses. Contracts-for-difference, or CFDs, are made off exchanges, which allow investors to hold stakes in excess of 5% in a company without having to report their holdings or transactions to regulators.
As Bloomberg suggests, Archegos likely did not own most of its underlying securities, because there is no delivery of securities or physical goods with CFDs required. News of Archegos’ sudden default echoed around the globe come Monday, after several prominent banks including Goldman Sachs and Morgan Stanley forced Hwang’s hedge fund to liquidate investments worth billions of dollars that were acquired via the highly leveraged bets. The mass selloff caused a number of tech and media stocks to fall, including Baidu Inc, Discovery Inc, and VIPShop.
CFDs and swaps are categorized as custom-made derivatives that are privately traded between investors, or over-the-counter, instead of public exchanges. The underlying obscurity of such derivates exacerbated the 2008 financial crisis, causing regulators to introduce new rules to govern the use of the assets. According to Bloomberg calculations, over-the-counter equity derivatives account for only a small portion of this ambiguous market. In the first half of 2020, equity swaps amassed a gross market value of $0.28 trillion, compared to the $2.4 trillion for swaps linked to interest rates.
As is the case with Archegos, very little is known about Hwang’s trading details, except for market participants suggesting his assets have ballooned to anywhere between $5 billion to $10 billion over the past several years, with total exposure around $50 billion. It is worthwhile to note, however, that Hwang’s leveraging is strictly synthetic, in that the hedge fund does not have an underlying stock to default to, and is instead exposed to margined losses (and gains).