Archegos meltdown, GameStop drama underscore need for more hedge-fund disclosure, reformers say

The latest market turbulence comes as Congress is already paying close attention to disclosure rules


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Financial markets remained somewhat volatile on Tuesday as investors surveyed the damage wrought by the failure of hedge fund Archegos Capital Management, an event that, along with the drama surrounding a recent short squeeze in shares of GameStop Inc. , underscores a continued lack of transparency in financial markets with respect to derivatives and short selling, financial reform advocates told MarketWatch.

“A lack of disclosure is a big part of how this thing went pear-shaped in my view,” said Tyler Gellasch, executive director of Healthy Markets, a nonprofit organization of investors that advocates for financial reform.

Read more: Robinhood back in Capitol Hill spotlight amid surge in GameStop shares

The Securities and Exchange Commission requires all investors with more than $100 million in assets under management to publicly announce their equity holdings 45 days after the end of a quarter, but these 13(f) filings can be misleading because investors are not required to announce their derivative holdings, or to say which stocks they are borrowing to sell short, a method of betting that a stock’s price will fall.

Archegos’ Bill Hwang reportedly ran up big debts with large banks including Credit Suisse Group AG
Nomura Holdings Inc.
Goldman Sachs Group Inc

and Morgan Stanley
among others, by effectively borrowing money to purchase derivative contracts linked to the value of stocks of major companies, including U.S. media firms ViacomCBS Inc.

and Discovery Inc.

But Viacom’s decision earlier this month to issue $3 billion in new stock catalysed a slide in the firm’s stock price, triggering collateral calls that Hwang was unable to meet. Banks followed suit, selling shares in the firm’s Hwang was placing long bets on, leading to a further collapse in the value of Archegos’ portfolio. Viacom shares, for instance, fell 27% on Friday, it’s largest single-day loss on record, according to Dow Jones Market Data.

See also: Viacom stock extends slide, as analysts chime in with lukewarm upgrades

That sort of market volatility, and the large losses suffered by the investment banks that Hwang dealt with, could have been avoided if the SEC were to update its rules to require that large hedge funds and other institutional investors disclose when they have large positions in a company through equity derivatives, Gellasch argued.

“If [disclosure rules] covered long synthetic positions, then the counterparties could all know of everybody else’s significant exposure,” he said, adding that the large banks that were selling derivative contracts to Hwang would have understood the risks they were taking and declined to sell as aggressively to him, or hedged their risk more appropriately.

The SEC did attempt to reform rules around 13(f) disclosure rules last year under former Chairman Jay Clayton, but the attempt was to make them less stringent by raising the assets under management threshold that triggers the report. The backlash against the proposal from the financial services industry was nearly universal, underscoring how important market participants find these disclosures.

Corporate executives were one group that forcefully argued against scaling back the 13(f) disclosure regime, as they see these requirements as essential for understanding who their shareholder base is. Both the New York Stock Exchange and Nasdaq Inc.

have publicly endorsed requiring institutional investors to report their short bets, but have not gone so far as to argue that synthetic bets should be made public too.

“Market intelligence is critically important for boards of directors,” Joshua Mitts, a securities law expert at Columbia University told MarketWatch. “It turns out that it’s really quite critical what your trading base looks like and the market risks that might come about as a result,” he added, noting that Viacom directors may have thought differently about issuing new stock if it better understood the nature of its shareholder base at the time.

Meanwhile, Gellasch argued, that “This isn’t just meme stocks and penny stocks. Extreme volatility in the market values of large, well established companies raise big questions about the stability and integrity of the markets, and that has to be a major focus for the SEC and investors,” he said.

That the GameStop

saga and the events surrounding Archegos Capital Management happened in such quick succession could spur the SEC to revisit the 13(f) regime, given recent hearings on the topic at the House Financial Services Committee and the Senate Banking Committee, where lawmakers of both parties have expressed concern over the lack of transparency surrounding the market for borrowing and short selling stocks.

“We have been monitoring the situation and communicating with market participants since last week,” an SEC spokesperson told MarketWatch.

What could put added pressure on the SEC to act was the potential that Archegos’ failure could have triggered a broader market panic, given the reported losses suffered by some globally systemically important banks in an environment of elevated asset prices where there remain serious questions about the health of a global economy that has yet to recover from the COVID-10 pandemic, Mitts argued.

“There are a lot of macro vulnerabilities right now, and these things can spiral and cascade,” he said. While it appears so far that the long term effects of this episode will be limited, the event shows that “there are exposures that we’re not aware of, and one crash can always lead to another.”