US markets regulators have proposed rules to inject more transparency into the derivatives that blew up hedge fund Archegos Capital, which would compel investors to disclose swaps positions that have allowed them to build up unseen holdings in public companies.
The regulations put forward on Wednesday by the Securities and Exchange Commission would require additional disclosures of holdings of security-based swaps once they exceed $300m or account for 5 per cent of a company’s stock, information that financial markets and the US securities regulator currently lacks.
Investors would be asked to disclose information including their security-based swap positions — in which an investor can effectively invest in an asset without purchasing it directly, avoiding disclosure requirements — and their identities as well as any related securities or loans.
“In March, when Archegos Capital Management collapsed, we saw once again the risks that might arise from the use of another security-based swap — total return swaps,” said Gary Gensler, SEC chair.
“At the core of that story was Archegos’ use of total return swaps based on underlying stocks, as well as significant exposure that the prime brokers had to the family office.”
Archegos sent shockwaves through US financial markets earlier this year when a series of highly concentrated bets on the share price moves of companies such as ViacomCBS and Discovery backfired.
The family office, run by Bill Hwang, had purchased total-return swaps from some of Wall Street’s largest banks worth tens of billions of dollars.
The structure of the trades meant Archegos could get exposure to the share price moves in dozens of stocks without owning the shares outright. Instead, the banks it traded with — a list that included Goldman Sachs, Morgan Stanley, Credit Suisse and Nomura — would buy the underlying shares and would swap returns based on how the stocks moved.
Archegos replicated similar trades at many of the prime brokers with which it traded, and did so largely on margin, using borrowed money from banks.
But as the share prices of several of the companies it had wagered on fell, Archegos suffered catastrophic losses. In March, it defaulted on margin calls and banks across Wall Street recorded more than $10bn in losses tied to the incident.
The SEC, which has oversight of equity swaps, was criticised for its slow pace of rulemaking and the fact a little known trading outfit could inflict such large losses on the banking sector.
The proposals are based on powers granted to the SEC in the 2010 Dodd-Frank Act, which were intended to curb excessive risk taking in the derivatives market after the 2008 financial crisis, but have been repeatedly delayed.
Gensler said the push for transparency had also been influenced by the implosion of hedge fund Long Term Capital Management, which had used swaps to leverage its positions more than two decades ago.
“The jitters, if I could call it, around total return swaps, and the lack of transparency in 1998, in 2008, in 2020 informs me when I think about these things,” he added.
The SEC on Wednesday also disclosed potential rules for money market funds. The commission proposed to have funds hold at least 25 per cent each day, and 50 per cent each week, of their total assets in liquid assets. Current requirements sit at 10 per cent a day and 30 per cent a week.
The increased thresholds are meant to prevent the kind of stress on money market funds seen during the sell-off in March 2020, when investors pulled billions of dollars from prime money market funds as they raced into cash, and funds struggled to meet the redemptions.
The jump in minimum requirements “would provide a more substantial buffer to better equip money market funds to manage significant and rapid investor redemptions,” the regulator said.
Data from the Investment Company Institute, which tracks the nearly $5tn money market fund complex, showed that prime money market funds in November cleared the daily liquid asset threshold proposed by the securities regulator, but fell slightly below the new weekly hurdle.
The SEC will now seek public comment on the rules, which were proposed during an open meeting on Wednesday.
Additional reporting by Philip Stafford in London
