Archegos Capital Management’s blow-up and its consequences for the financial sector have led to calls for the regulation of family offices. But I do not believe this should, or will, happen.
The Archegos scandal is a classic example of a leveraged market bet that went wrong, and the way the bet has hurt some of the most prestigious names in global banking. It also involves a family office, big banks, exotic financial engineering, and a lack of transparency.
Sounds familiar? Yes, because, take out the family office part of the equation, and replace it with a hedge fund, which effectively Archegos was, and the scandal reeks of scandals of the past where financiers with privileged access to the markets manipulate them to make spectacular profits – until it all goes wrong.
And just as they have in the past, the scandal has sparked a reaction from politicians, regulators and the media. US Democrat Senator Elizabeth Warren was quick off the mark, telling CNN that the Archegos scandal showed: “Regulators need to rely on more than luck to fend off risks to the financial system.”
More potent, and more forceful, sentiment, especially concerning family offices, was expressed by Dan Berkovitz, a commissioner with the US Commodity Futures Trading Commission. In a statement, Berkovitz said: “To protect the integrity of the commodity markets, the Commission (CFTC) must be aware of and able to monitor the activities of large family offices.
“In order to do this the Commission should have basic information about family offices that are operating commodity pools. The qualifications of persons operating family offices should be no less than for persons operating other exempt and non-exempt pools. ”
Add in the anti-rich voices from the progressive wing of the US Democrat Party, cheered on by the media, and regulation for family offices looks more likely than at any time in the past.
However, a one-size-fits-all approach doesn’t work in the family office world, as can be the case with the banking or hedge fund worlds.
The saga began as a result of regulation following the financial meltdown of 2008 following Dodd-Frank legislation, which came down hard on hedge funds. To avoid scrutiny from the regulator, many hedge funds decided to ditch outside money and effectively convert to family offices.
Some of the big names that did this included George Soros with Soros Capital Management and Stanley Druckenmiller with Duquesne. More than 100 hedge fund managers did the same. Bill Hwang was a hedge fund manager before establishing his Archegos family office.
But, taken together, all these new family offices comprise a maximum 5% of the universe of single-family offices. And many of them aren’t remotely interested in hugely complicated synthetic financial product based on massive leverage to make extraordinary profits. Not least because their own capital is at stake.
What’s more, hedge fund managers, and their family offices, often invest in the most innovative businesses around. Businesses that will benefit society as a whole, including Louis Bacon’s Moore Strategic Capital, which has been one of the principal backers of Commonwealth Fusion Systems, Jim Simons’ Euclidean Capital investment in Alector, a biotech group developing antibody technology for the treatment of Alzheimer’s disease and Soros Fund Management’s backing for electric vehicles.
The remaining 95% have been run by principals who own a successful operational business or the proceeds from selling one. Most of these businesses have very little to do with the financial sector, putting aside the occasional hedge, and few of them invest in hedge funds to any significant extent.
They often invest in early-stage businesses far too risky for institutional and public money to get involved. Yes, the bigger ones have the money to do so, but they risk their capital and not pension funds, or tax-funded capital.
Family offices are so crucial to the overall innovation process in the world economy that undermining them in this respect would have big negative consequences for economic growth. The US could kiss goodbye to its space programme, nuclear fusion and much else besides. And the Democrats could kiss goodbye to most of their wealthy supporters.
I would expect cool heads at the Securities and Exchange Commission, the US Treasury – even the CFTC – to realise this and forestall a crackdown on family offices. The rhetoric is strong now, but will probably subside in the weeks ahead.
Of course, the Archegos scandal hasn’t played itself out entirely yet. How much it will feed through to the real economy isn’t fully known. The banks who got involved with Hwang are already paying a heavy price, Credit Suisse has just confirmed a loss of $4.7 billion, and the departure of its chief risk officers.
But so far, the systemic risk of the Archegos scandal looks minimal. That’s what regulators will be looking for before making any decisions on family offices.