This review is strictly a summary of my interpretation/smooth brained understanding of the 163 page Credit Suisse report, in particular, section 1A: https://www.credit-suisse.com/media/assets/corporate/docs/about-us/investor-relations/financial-disclosures/results/csg-special-committee-bod-report-archegos.pdf
A few things to start off with: according to the Credit Suisse Report, Archegos was margin called due to their LONG positions on swaps, not their shorts. Additionally, their main game was swaps. It’s all in the report. While the report largely debunks the idea that Archegos was margin called because of GME, it provides great insights into the relationship between the prime brokerage and its clients. More importantly, it provides insights into the contractual margin agreements between a prime brokerage and its clients. Through this report, we can gain insights into how other hedge funds are operated, and their portfolio requirements and relationship with their prime brokerage (for example, the SHFs that haven’t been liquidated yet).
The big takeaway that I got: Credit Suisse may have forced Archegos to short the subprime meme swaps to maintain portfolio requirements. In fact, if Archegos’ portfolio agreement is industry standard, it’s possible that every single hedge fund/family fund in operation may have taken short positions on these swaps to maintain portfolio requirements with their prime brokerage. Yup, you read that correctly. Voltron fund baby!
How did this happen? Archegos worked with CS for many years, and built up a good relationship with CS. As a result, their deals got sweeter and sweeter over the years. In 2017, Archegos entered into an agreement with CS: their portfolio (roughly 20% margin at this point) would never breach a 75% bias long or short (page 8). In ape speak: Credit Suisse would front 80 cents on the dollar for every position Archegos bought, but Archegos would promise to never have more than 75% of their portfolio be long or short. Over the next few years, Archegos would actually breach this limit: more than 75% of their portfolio was long, but CS would give them up to 5 months to get their portfolio back on track.
That’s right: their portfolio was 75% long positions in total return swaps. They did not carry a heavy short position on GME (intentionally). Well, in 2019, Archegos’s relationship got so sweet with CS, CS dropped their margin requirement to 7.5% on new positions. That is a roughly 13x leverage. That’s 92.5 cents on the dollar. Sweet. Of course, this presents massive risk, and Archegos starts getting regular calls from Marge. At some point, their position had dropped enough to be liquidated. We all know that. How does this deal with shorting GME?
Remember their original agreement? Their portfolio could not breach a 75% long position? Archegos was primarily in the business of long positions. However, they would breach that 75% long position at multiple points over their agreement period. Archegos had two options: reduce their long position (i.e. sell their longs), or increase their short position (i.e. short the market). If you look at page 10 of the report:
Rather than call additional margin, as was its contractual right, CS attempted to re-balance Archegos’s portfolio by requiring that it add market shorts (for instance, index shorts referencing the S&P 500 or NASDAQ 100).
That’s right: when Archegos breached its margin limits or had overexposed long positions in 2020, CS forced Archegos to buy short swaps.
In 2020, in the height of the pandemic, when stimulus is making the S&P 500 roar, and people are all self-isolating, would you open a short swap position on a basket of S&P 500 funds? Fuck no. If I had to, I’d short the hell out of the pandemic plays: cruise ships, commercial real estate, and strip mall operators…like Gamestop and Movie Stonk… Now, CS does not say that Archegos opened short positions on GME, only that CS forced them to open short swaps on index shorts referencing… something. You know it, I know it, they probably shorted GME.
Do you work? Do you have a friend that works? Have a 401k? Roth IRA? I bet at some point either you, or someone you know has opened up a long position on an S&P 500 index fund or a total market index fund. Why did they do it? Well, because someone smarter than them has put together an index fund that tracks the market, and they trust that the folks who put together the basket knew what they were doing. That the stocks are weighted correctly. That the index is well managed. That’s what ETF baskets are for. Someone smart puts together a basket, weighs it accordingly, and sells the basket on the market. Hell, a lot of retirement plans force you to put your money into an index or a fund. You don’t even have a choice.
Well, what if someone put together a basket of shortable pandemic plays like GME and movie stonk? Maybe another basket for cruise ships? What if your brokerage forced you to buy 25% of your portfolio in these swaps? Well, if you were primarily a long hedge fund, you’d just allocate 25% of your money to the short indexes without doing the due diligence, while focusing on your long positions. Just like regular folks just focus on their jobs and dump their money into their index funds without doing the due diligence.
Now imagine that Marge is calling because you breached your limit…you need to post collateral, or you need to short something, anything, to keep within your defined portfolio risk profile. If you’re a long positioned hedge fund, you probably don’t research short positions. You would probably just pick one of the basket of shorts labelled “pandemic plays” that was put together by SHF quants (i.e. Citadel), and continue along with your game. Every time Marge calls because your portfolio is imbalanced? No problem, just short a basket, and keep it at 25% or more of your portfolio. Until an idiosyncratic risk in your 25% short exposure fucks you over.
What am I trying to say? It’s possible that prime brokerages require hedge funds with margin to maintain a ratio of long/short positions to mitigate risk. If so, it’s possible every single hedge fund out there shorted GME in 2020 without knowing it, because their prime brokerage forced them to maintain a short position on a portfolio swap as a way to hedge their risk on their long positions. Imagine if your S&P500 index fund had an infinite loss potential stonk tucked into those 500 stocks that had the potential to liquidate your whole portfolio, and actually leave you in debt. Wow. Fuck. Now you know why they needed to contain the January sneeze.
Idiosyncratic risk to the moon.