Archegos Capital: Will Indian market see another Lehman moment?

Market Outlook
Source: Reuters

Source: Reuters

There is a popular saying, “History does not repeat itself, but it rhymes”.

The recent debacle at Archegos Capital has brought back some bad memories of the Lehman Brothers debacle in September 2008.

The US markets did see a knee-jerk reaction, but, back home, both the Sensex and the Nifty saw a massive rally of more than 2 per cent each, which pushed the S&P BSE Sensex back above 50,000, while the Nifty50 reclaimed the 14,800 levels.

Experts Moneycontrol spoke to assured investors that the world has learnt a lot from the Lehman Brothers crisis, and it is unlikely that it will happen all over again. The impact on Indian markets will be limited.

Archegos is a New York-based family office fund that primarily invests in stocks in markets like the US, China, Korea and Japan. It was forced into a fire sale—selling assets at a very low price— of securities worth around $ 20 billion last week after some of its portfolio stocks witnessed a significant price fall.

Archegos had huge exposure through swaps in Viacom, CBS Corporation and Discovery Communications, along with Chinese majors Baidu Inc and Tencent Holdings.

The fall in market prices of its portfolio stocks triggered margin calls and the failure to bring in additional margins forced marquee banks, including Nomura, Credit Suisse, UBS, Deutsche Bank, Goldman Sachs and Morgan Stanley, to liquidate the holdings of Archegos..

Also Read: What is Archegos and what does it mean for Indian markets, explained

Archegos Capital’s debacle is not a systematic risk. Deleveraging which took place is thematic in nature, consisting more of Media and Entertainment stocks which are not widely held in concentration. The impact will be limited to thematic funds, say experts.

“There will be portfolios/accounts where these stocks may be part of, but would that not impact diversified portfolios much. Indirect impact, too, as of now, is confined to quarterly profits getting wiped off for banks under consideration,” Siddarth Bhamre, Director, Alternate Investments & Research, InCred Capital, told Moneycontrol.

“So, as of now, the probability of this issue creating an avalanche of sell orders globally is very less. A Lehman- like moment, not necessarily, should emerge within the said country. As we are at least financially one global village, such tragedies can’t hit us from any direction if risk management aspects are compromised,” he said.

Leverage— a double-edged sword

An investor can amplify his/her profits through leverage positions, without putting full capital/cash of his/her own. Well, a similar story played out in Archegos Capital case as well.

Archegos had assets of around $ 10 billion but held positions worth more than $ 50 billion, according to a Reuters report, quoting sources. The fund bought derivatives known as total return swaps which allow investors to bet on stock price moves, without owning underlying securities, it said.

Swaps allow investors to take huge positions without having to remit large sums of money upfront. They do essentially by borrowing from banks— called leverage in market parlance.

“Leveraging is a double-edged sword and can make or break your investment portfolios — be it individuals or institutions. Over-leveraging is a strong signal that risk management aspects are getting compromised and depicts that somewhere some rules and regulations are getting violated,” said Bhamre.

Over-leveraging, eventually, leads to a disaster if the underlying security starts showing unfavourable price movements. With exotic and structured derivatives products, it becomes very easy to take high exposure with the limited capital deployed.

Let’s understand with the help of an example

Suppose you put $ 10 billion as margin collateral and create a $ 50 billion exposure in markets through funding facility (borrowed funds).

Scenario 1: If the market position rises by 20 per cent in value, the $ 50 billion becomes $ 60 billion, giving you a bumper profit of $ 10 billion.

Scenario 2: If there is a 20 per cent fall, the $ 50 billion will go down to $ 40 billion, wiping out 100 per cent of your own capital of $ 10 billion.

“When prices start falling, your brokers/banks which have funded these positions will scramble to sell the margin collateral/margin shares to recover losses as they go out-of-pocket (a situation where the value of Mark-To-Market Loss is higher than the value of margin collaterals). This creates a contagion effect in the market as everyone wants to sell these shares,” Piyush Nagda, Head, Investment Products, Prabhudas Lilladher, told Moneycontrol.

“Indian markets have seen such episodes in the past, especially in mid- and small-cap shares, driven by promoter-operator nexus. In India, brokers/banks don’t wait till a 100 per cent fall in the value of margin collaterals,” he said.

Nagda further added that in Archegos Capital’s case, the situation seems to have gone beyond control where some players like Nomura and Credit Suisse seem to have gone out-of-pocket and are staring at a big hole.

“We don’t know the exact extent of losses, but media reports say that it could be to the tune of $ 1-4 billion for these players,” he says.

What do the statistics say?

In India, we have seen the IL&FS issue, which saw many NBFCs and financial stocks, including some banks, correcting substantially, triggering margin calls.

Archegos is related to one specific hedge fund and not an asset class in general like we saw in the case of the Lehman crisis. The way Archegos built positions was through swaps, and not treasuries, which is often governed by ISDA (International Swaps and Derivatives Association), so that there should have been some collateral for the margin.

“If this collateral was US treasuries, this unwinding can lead to the sell-off of treasuries which can widen bonds, and, hence, deflate equity prices in India, but this impact is limited in my opinion. This is an evolving story, and we might be surprised as more facts come out,” Abhishek Banerjee, CEO, Lotusdew, told Moneycontrol.

“India has strict margin requirements. We, at Lotusdew, track margin reported at as aggregate across all brokers and scripts that have been purchased on margin. Currently, we see margin outstanding of about $ 1.5  billion across all brokers in India for a total market size of over $ 2 trillion,” he said.

Banerjee added that when compared to the US, the reported broker margin of $ 798 billion vs $ 25 trillion in the US market, India seems to be very conservative on the total margin exposure.  exposure.

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