Review of 2021: Default, revolt, reform

A secretive household workplace triggers one of the most important buying and selling losses in historical past. An military of retail traders single-mindedly hunts down quick sellers within the inventory market. The world’s most essential monetary benchmark marches inexorably in direction of demise.

While the final of these seismic occasions was stage-managed – to the extent attainable – the others weren’t. The rise of Reddit’s retail military was anticipated by some, as home-workers ploughed their financial savings right into a Bolshie new type of inventory buying and selling, however the explosion it set off in January got here as a shock to most. And the failure of Archegos Capital Management was a five-alarm fireplace. Against the backdrop of a mutating virus and rising world temperatures, this was a precarious, disorderly yr.

It was additionally a narrative of adaptation and survival. Despite taking large losses, banks managed the Archegos collapse with out systemic tremors. Robinhood Markets, the net low cost dealer on the centre of the meme-stock frenzy, narrowly prevented defaulting on its clearing obligations. Trillions of {dollars} of derivatives efficiently strapped on their contractual parachutes forward of Libor’s demise.

None of these tales finish with the calendar yr, of course. The Archegos debacle has reworked the prime brokerage panorama and will result in new leverage and risk-taking curbs for hedge funds. The retail buying and selling increase has modified the construction and dynamics of fairness markets. And a number of various benchmarks – some eyed with contempt by regulators – are vying to fill the void left by US greenback Libor.

Meanwhile, stress continues to construct on monetary corporations to do their half within the struggle towards world warming.

Here, we glance again at some of the yr’s greatest Risk.web articles.


When Credit Suisse misplaced $5.5 billion from the collapse of a single shopper, it prompted a single query: how?  

The easy reply is that the shopper was allowed to tackle far an excessive amount of leverage. As Risk.web revealed in April, Archegos posted a mean margin of simply 10% towards the fairness swaps it traded with Credit Suisse.

But the Swiss financial institution’s lax margin practices have been arguably simply the symptom of a deeper malaise. The loss was a case examine in all the things that may go mistaken in a risk-taking enterprise: overworked and underqualified employees; multi-hatting; outdated expertise; unhealthy choices; missed purple flags; an aggressive gross sales tradition that overwhelmed danger administration; and a scarcity of accountability and accountability amongst senior leaders.

An impartial report printed in July laid naked the “elementary failure of administration and controls” at Credit Suisse and confirmed a lot of Risk.web’s earlier reporting. It must be required studying for all danger managers, and anybody concerned in funding banking.

“[We’ve had] a 15% ground on single names for many years” – head of danger at a rival clearing financial institution (Credit Suisse held simply 10% margin towards Archegos ebook, April 30)

“It’s not that prime brokerage is inherently dangerous. It’s that some of these banks are dangerous as a result of they’re Frankenstein creations and no one is aware of what’s happening and the place the danger is” – Carson Block, founder of Muddy Waters Capital (Credit Suisse and the Wild West of artificial prime brokerage, May 11)

“This was due partially to a scarcity of competence (together with a failure to understand apparent and extreme dangers) in addition to a tradition by which earnings have been prioritised over sound danger administration and respect for controls” – impartial report on Credit Suisse loss (Archegos report particulars margin failings at Credit Suisse, August 21)


This wasn’t only a Credit Suisse story. The collapse of Archegos left a minimum of 5 massive banks with collective losses exceeding $10 billion. The fallout was swift. Nomura suspended its money prime brokerage operations exterior Asia and Credit Suisse exited the enterprise fully. Others have tightened danger controls or taken a extra assertive stance with purchasers – JP Morgan reminded hedge funds it had the suitable to name for margin intraday.

The retrenchment is prone to restrict credit score availability and lift leverage prices for hedge funds, a minimum of within the short-term. Further adjustments might be coming. One advice within the report into Credit Suisse’s loss – giving derivatives valuation adjustment (XVA) desks a wider position in pricing and even vetoing trades with hedge funds – is gaining wider traction within the business.

The debacle additionally raised severe questions for regulators. Archegos used fairness swaps to accumulate large stakes in a handful of firms with out alerting its counterparties or the broader market. Long-delayed margin guidelines for these devices lastly got here into pressure on November 1. The following month, the US Securities and Exchange Commission proposed new disclosure and anti-fraud guidelines for security-based swaps. Banking regulators have additionally signalled that scrutiny of counterparty credit score danger administration will intensify. 

Archegos might have pale from the headlines, however its collapse will reverberate for years.  

“Initial margin is exactly there to handle close-out danger on defaulted positions. It might not work each time however it offers a secure, systematic buffering of the system” – Donal Gallagher, president of Quaternion Expert Services (Would margin guidelines have checked Archegos? Perhaps not, April 14)

“The JP Morgan commonplace prime brokerage settlement truly says that they will name you each time they need for variation margin – like you possibly can rise up to seven calls a day” – head of treasury at a big US hedge fund (JP Morgan warns hedge funds to anticipate intraday margin calls, July 13)

“The patchwork of regulatory companies within the US implies that despite the fact that one regulator might have the suitable info, that isn’t but assured to increase throughout all regulators” – Josh Galper, CEO of Finadium (Archegos reveals up US swaps reporting shambles, July 13)

“We completely have veto or be happy to raise an outsized danger for a portfolio. All trades over a sure threshold need to be authorized by me” – head of XVA at a US financial institution (After Archegos, a much bigger position for XVA desks?, October 6)


Even earlier than Archegos collapsed, there have been hints of extreme leverage within the banking system. An article printed by Risk.web on March 1 revealed Nomura had reported extra collateral acquired than whole stability sheet property for the previous 4 years. The discrepancy is defined by the truth that collateral acquired in securities financing trades may be bought or repledged in different transactions with out being recorded on the stability sheet. The final main financial institution to run up such massive off-balance sheet exposures was Lehman Brothers. Nomura had the second-largest publicity to Archegos, with losses totalling $2.9 billion.

But it’s in no way the one financial institution to interact on this type of off-balance sheet exercise. Collateral velocity – the reuse charge of securities in funding transactions – hit its highest degree in a decade on the finish of 2020, as world banks responded to the hedge fund business’s rising demand for leverage. An evaluation of financial institution stability sheets suggests the leverage capability accessible to hedge funds at first of 2020 was increased than at any level because the 2008 monetary disaster. The off-balance sheet nature of these transactions meant the dangers weren’t adequately captured within the leverage ratio, the regulator’s final backstop towards systemic danger.

“The leverage ratio performs the half of a big brake on the reuse of collateral within the banking sector, so we don’t have to strengthen these guidelines additional. The challenge is to use them to non-bank entities” – Denis Beau, deputy governor of the Banque de France (What lies beneath: Nomura’s iceberg stability sheet, March 1)

“The leverage capability – each on- and off-balance-sheet – accessible to hedge funds is increased at present than at any level previously decade” – Manmohan Singh, senior economist on the IMF, and Phil Prince, companion at Pine River Capital Management (Hedge funds and the rebound in collateral velocity, June 7)


Shares of GameStop shot up greater than 1,600% in January when internet-savvy retail merchants clubbed collectively to place the squeeze on hedge funds that had wager towards the struggling online game retailer. Clearing homes finally paused the frenzy, which created large dislocations in fairness markets. Robinhood, the buying and selling app standard with retail traders, halted purchases of GameStop and a handful of different so-called meme-stocks after being hit with a mammoth $2.2 billion capital cost.

The buying and selling limits brought on GameStop shares to crash practically 90% and drew the ire of clients. But issues might have turned out even worse. The money name from the National Securities Clearing Corporation far exceeded Robinhood’s money readily available and borrowing capability – it might have been declared in default and its purchasers’ positions liquidated. NSCC as an alternative used its discretion to waive the cost – a call that left its largest member corporations with blended emotions.

NSCC’s defenders say liquidating Robinhood even because it was taking steps to decrease its danger would have unleashed chaos on the markets. Its critics declare the clearing home’s actions created an ethical hazard which may result in even greater issues sooner or later. 

Retail traders appear largely unconcerned by the close to miss. Many are embracing extra complicated choices methods and setting their sights on even greater targets, corresponding to Apple and Tesla. Banks and huge asset managers have responded by growing meme-stock components that search to trace retail flows and capitalise on them. The tug of battle between retail and institutional cash appears to be like set to proceed properly into 2022. 

“Investors have expertise of shares which might be 20%, 30% or 40% volatility, however whenever you get to 500%, all of a sudden your regular assumptions will exit the window” – Chris Murphy, co-head of technique at Susquehanna International Group (Options pricing framework buckles below GameStop frenzy, February 3)

“This is a clearing home. They shouldn’t have the choice to waive just a few billion {dollars} [from a risk charge]” – chief danger officer at a clearing agency (Hero or villain? NSCC attracts fireplace for Robinhood margin waiver, March 31)

“If we have been capable of see the possible drivers of these inelasticities, corresponding to extra retail participation or extra authorities involvement in markets, that will translate into return predictability” – Vitali Kalesnik, head of analysis at Research Affiliates (Inelastic markets: how index funds fuelled the meme inventory frenzy, April 7)


Transition away from US greenback Libor was thrown into turmoil in March after the market’s key working group warned it could miss a mid-year deadline to approve a time period model of its most popular substitute, the secured in a single day financing charge, or SOFR.   

With the arrival of time period SOFR unsure, mortgage markets – which have been already involved in regards to the new benchmark’s lack of credit score sensitivity – started wanting significantly at alternate options, corresponding to Ameribor and the Bloomberg Short-Term Bank Yield (BSBY) index, with the latter garnering probably the most curiosity from massive banks and corporates. 

Bank of America examined the waters with a $1 billion floating charge be aware referencing BSBY in April, whereas US workwear firm Duluth Holdings grew to become the primary company to hyperlink a syndicated mortgage to the index in May.

The rising momentum behind BSBY appeared to galvanise a response. On May 21, a working group – the Alternative Reference Rates Committee – chosen CME because the official supplier of time period SOFR and adopted by with a full endorsement in July.

But the genie was already out of the bottle. By the summer time, the market had seen greater than $1 billion notional of swap transactions linked to BSBY, together with fixed-to-float devices out to 10 years, prompting a trenchant response from regulators. At a June assembly on systemic danger, US Securities and Exchange Commission chair Gary Gensler cautioned towards widespread use of BSBY, which he mentioned had “many of the identical flaws as Libor”. That turned out to be simply the opening salvo in a barrage of regulatory assaults that slammed the brakes on credit-sensitive charges forward of the year-end deadline to stop new Libor issuance. But with lenders nonetheless uneasy about risk-free charges, it stays too early to jot down off BSBY and its friends.    

“Our skill to advocate an administrator and endorse a selected charge was all the time contingent on sure circumstances. There’s simply been slower take-up [of SOFR derivatives] and a few of these circumstances haven’t been met” – Tom Wipf, chair of the Alternative Reference Rates Committee (US stumbles in pursuit of time period SOFR, March 25)

“It may look like an enchancment on Libor, or a extra resilient benchmark, however I’d counsel we not make that mistake” – Gary Gensler, chair of the Securities and Exchange Commission (SEC’s Gensler takes goal at Bloomberg’s BSBY index, June 14)

“I’ve by no means been extra bullish a couple of world of a number of benchmarks” – Richard Sandor, chief government of the American Financial Exchange (Pick a charge: pitfalls and prizes within the post-Libor world, July 6)

“The regulatory pressures and blocks to BSBY have meant that no one can proceed with buying and selling it. Even although there’s some need for this as a danger administration instrument, it’s just about useless within the water” – head of charges buying and selling at a big European financial institution (Regulatory assaults deal BSBY swaps a crippling blow, October 12)


Quants in search of to use machine studying to finance have run up towards a easy actuality: a scarcity of sufficient real-word information to coach their fashions. One resolution is to create artificial datasets with the identical statistical qualities as the actual factor. These so-called market mills spit out huge portions of real looking however fictional information, which can be utilized for myriad functions, from coaching predictive techniques to stress-testing portfolios.

The thought took maintain this yr. Amundi, Europe’s largest asset supervisor, started utilizing artificial information to check some of its volatility buying and selling danger parity methods. Quants at Bank of America discovered {that a} neural community educated utilizing faux information did a greater job of forecasting strikes in US Treasury bonds than conventional fashions.

The strategies used to generate artificial datasets are advancing quickly. A brand new paper authored by a number of distinguished quants and printed on Risk.web in June proposes utilizing ‘signatures’ – mathematical objects that may shortly and effectively encode monetary information – to create artificial datasets that seize the essence of monetary markets. Models utilizing signatures have been proven to retain info extra effectively than present information mills and might derive helpful info from even small pattern units. This might make it attainable to use machine studying strategies such because the deep hedging algorithms developed by JP Morgan to extra unique and sparsely traded devices. Another barrier to the widespread utility of machine studying in finance seems to be falling away.

“We can create artificial collection which might be indistinguishable from the unique. That’s the place the joy is coming from” – Blanka Horvath, an instructional at King’s College London (In faux information, quants see a repair for backtesting, May 19)

“With synthesising, you possibly can replicate the form and type and measurement of the information that you simply’re making an attempt to make use of with out the trouble of having to ask a vendor like Bloomberg in addition to your authorized crew whether or not you should utilize it” – Erik Mostenicky, senior affiliate at Fidelity International Strategic Ventures (Quants flip to machine studying to unlock non-public information, July 1)

“The signature technique can take a value motion path, convert it right into a set of coefficients that describes the form after which we are able to return in time and take a look at what has occurred when there have been comparable shapes earlier than” – Gordon Lee, government director in portfolio quantitative analytics at UBS’s funding financial institution (‘Signatures’ promise quants a instrument for all jobs, October 13)


The euro swaps market grew to become the venue for a fierce tug-of-war between the European Union and its former member state – the UK – over the availability of clearing companies. After Brexit, the EU gave UK central counterparties (CCPs) short-term permission to proceed clearing trades for European purchasers till June 2022.

The waiver was meant to offer EU corporations sufficient time to scale back their dependence on UK clearing homes and European officers signalled early on that it could not be prolonged. They spent a lot of the yr pressuring banks and buy-side corporations to maneuver euro swaps from LCH in London to Eurex in Frankfurt, with blended outcomes. Most end-users took a wait-and-see strategy, wagering the EU wouldn’t danger the disruption of a hasty, compelled relocation of trillions of euros in swaps. Others quietly break up their swaps books between LCH and Eurex, whereas taking nice pains to maintain their intentions hidden from the market. In one of these circumstances, the investing arm of the Dutch insurance coverage big Aegon accomplished a years-long effort to rebalance its cleared swap portfolio throughout the 2 CCPs on the finish of 2020 – a narrative Risk.web advised in September.

That wouldn’t be sufficient. Going into the fourth quarter, greater than 70% of euro swap trades have been nonetheless being cleared within the UK. After some brinkmanship, the EU introduced the short-term waiver for UK clearing homes could be prolonged within the New Year. It’s not clear what, if any, further stress can be utilized to market members.

“Today, the necessary instrument the European Commission has in its arsenal [to move euro swaps] is the derecognition of UK clearing homes. That’s what they’ve of their authorized arsenal, however they realize it’s not good… the present textual content they’ve just isn’t credible. If they need to be credible of their threats, they should change it” – clearing supply at a big financial institution (Euro swaps clearing showdown pits banks towards Brussels, April 20)

“Especially at first, if it had been broadly recognized that we have been engaged on shifting some of our publicity, then we have been truly very anxious that we’d influence the idea degree. So we needed to be very cautious with that” – Derek Milner, portfolio supervisor at Aegon Asset Management (How Brexit break up Aegon’s euro swaps ebook, September 1)

“We want transparency relating to evaluation of UK CCPs’ long-term recognition as quickly as attainable. The clock is ticking” – Jan Ritter, head of hedging and treasury at ATP (Buy facet divided on euro swap clearing transfer, October 19) 


When confronted with a brand new danger, the usual regulatory response is to introduce new capital expenses to cushion towards potential losses and encourage corporations to scale back their exposures. That is proving tough with local weather danger.

New European guidelines requiring banks to publish a ‘inexperienced asset ratio’ of climate-friendly property have been met with open scepticism from the business, with critics arguing the measure would solely serve to push carbon-intensive firms to hunt out financing from non-bank lenders. 

To be efficient, capital necessities aimed toward curbing local weather dangers should account for the chance of polluting companies changing into extra sustainable over time – a contingency that’s laborious to objectively measure.

The Basel Committee on Banking Supervision is taking its personal crack at this downside, with a brand new report anticipated to look shortly. The world standard-setter might want to resolve whether or not local weather dangers may be included into the present capital framework, which depends closely on historic information, or if a wholly new strategy is required.

The purchase facet can also be fighting this downside because it appears to be like to align portfolios with world carbon discount targets. Asset managers in search of a forward-looking measure of local weather danger gravitated in direction of so-called implied temperature rise metrics, which gauge an organization’s contribution to local weather danger over a interval of time. The most generally used methodology, developed by MSCI, at the moment charges Shell as a greener funding than Europe’s largest operator of offshore wind farms. Regulators should keep away from falling into such traps as they search for methods to inexperienced the monetary system. 

“We want one quantity at present to know the place we’re on sustainable finance and the place we’re heading” – Piers Haben, director of banking, markets, innovation and customers on the European Banking Authority (EBA faces backlash over ‘inexperienced asset ratio’, March 10)

“If you’ll do capital add-ons in some unspecified time in the future, it should have to be primarily based on rigorous evaluation” – Robert Begbie, chief government of NatWest Markets (Weather, or not: is local weather danger simply half of credit score danger?, October 7)

“The challenge with implied temperature rise is that there isn’t any consistency out there” – Rory Sullivan, chief technical adviser on the Transition Pathway Initiative (MSCI’s temperature scores stir angst amongst inexperienced traders, December 22)


The US Treasury market was beset by volatility in 2021, as traders responded to weak auctions, rising inflation and the withdrawal of stimulus measures. The ructions, following on the heels of excessive illiquidity in March 2020, compelled regulators to confront structural weaknesses in what is supposed to be the world’s most secure market. 

Shoring it up won’t be straightforward. As with any market, there are competing pursuits. Non-bank market-makers and high-frequency merchants, which account for a big share of Treasuries quantity, need higher transparency and central clearing. That might not swimsuit sellers, who bid in main auctions and deal with most massive trades with buy-side purchasers.  

The Federal Reserve’s first effort at market reform – the creation of a standing repo facility to backstop liquidity throughout instances of stress – uncovered these fault strains. Sceptics insist the ability, which is at the moment accessible solely to banks and first sellers, will do little to enhance market resilience in its present type, and are calling for it to be opened as much as a wider vary of market members, together with non-bank market-makers and hedge funds. 

Other gadgets of the reform agenda – corresponding to central clearing and real-time commerce reporting – are prone to be much more contentious. Regulators will want all their ingenuity to craft a set of reforms that improves resilience within the US Treasury market with out upsetting its delicate stability. 

“The vendor group doesn’t seem to really feel a necessity to step in and say, ‘, the five-year is buying and selling on the mistaken value right here’ and supply liquidity. That’s not the vendor’s job anymore” – Michael de Pass, world head of US authorities bond buying and selling at Citadel Securities (Dealers warn of hassle forward as Treasury issuance swells, March 16)

“Greater transparency within the Treasury market most likely makes loads of sense. It’s a reasonably antiquated market, frankly” – William Dudley, former president of the New York Fed (The US Treasury’s nice market makeover, May 12)

“What’s attention-grabbing is that this facility solely actually solves liquidity-driven shocks … It’s rather more about September 2019 than it’s about March 2020” – Josh Younger, head of US charges technique at JP Morgan (Fed’s repo facility received’t finish US Treasury woes, specialists say, August 13)


For the higher half of a decade, banks have been struggling to make the economics of the shopper clearing enterprise viable. Rules launched after the 2008 monetary disaster require most vanilla swaps to be centrally cleared. But the leverage ratio limits the quantity of stability sheet clearing companies can eat. Faced with this actuality, many banks got here to view clearing as a help enterprise or platform that helps service strategic purchasers, slightly than a income generator in its personal proper.

Citi was one of the few exceptions. Required US shopper swap margins at its clearing enterprise grew from $4 billion in 2014 to a peak of practically $38 billion final yr – greater than every other financial institution. But the times of Citi’s hard-charging clearing unit towering over rivals could also be over. 

The financial institution performed an inside overview of the enterprise following the retirement final September of Jerome Kemp, its long-standing world head of clearing. That course of culminated in February with the clearing enterprise being re-housed within the financial institution’s equities division, led by Fater Belbachir.  Kemp’s replacements – clearing and FX prime brokerage co-heads Chris Perkins and Sabrina Wilson – left the financial institution just a few months later. Mariam Rafi was confirmed as Citi’s new world head of clearing in October.

The adjustments sign a significant shift in technique. Those now on the helm see clearing primarily as a service that helps extra profitable shopper exercise in equities and elsewhere. This might not be a wholesome factor for what is actually a danger administration enterprise.

“I think this isn’t an equilibrium level, with extra adjustments to return. Unstable provide just isn’t what you need from a utility” – an government at one of Citi’s largest clearing purchasers (Clear out: contained in the equities takeover of Citi’s FCM, October 4)

“It needs to be an ancillary enterprise, a help enterprise – it will possibly’t stand by itself below the present market construction” – a former clearing government (Citi reorg the ultimate be aware in failed swaps clearing mannequin, October 11)

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