Markets at a Glance
A strong March non farm payrolls report buoyed investor sentiment (+916k actual vs 675k expected). Equities rallied big time as SP500 touched all time highs while the 2–5y part of the treasury curve sold off as investors questioned the Fed’s resolve in keeping rates low against a strengthening economic backdrop. FOMC minutes to be released on Wednesday will certainly be gleaned for any insights into the Feds’ heads on the rate picture.
Good Reads
- Margin calls take down another fund faster than you can say 2008. Archegos levered itself to the hilt with the prime brokerage leverage that is making notorious headlines again as multiple firms (GS, MS, CS, Nomura) get snagged in Hwang’s whale of trading losses.
- Let’s dog food it ourselves and then make $$$$$. Brevan taking a page out of the BlackRock Aladdin playbook and licensing out their own trading platform Coremont to other investment managers. There is definitely money to be made in this space — in 2020, BlackRock earned more than $1 billion in tech services revenue, a category that includes sales of Aladdin software.
Prime Brokerage Leverage: What happens when it all goes down the tubes
The past week’s Archegos saga got me thinking about 2008 again and the 10,000 articles off the back of how prime brokers enabled Hwang’s penchant for risk taking made me want to explain how leverage can all go wrong in a down market.
Example: Lets say equity hedge fund ABC is levered at XYZ prime broker with a 10% margin requirement and then the value of position tanks.
FIRST:
market value = 100mm
margin posted (10%) = 10mm
debit = 90mm
THEN:
market value = 50mm
initial margin posted (10%) = 10mm
debit = 90mm => going to call you for 50mm (or 45mm if they readjust ur margin) because i’ve lent you 90mm and now it’s worth significantly less
Great, now you have to raise 45–50mm but in order to do that you have to unwind positions that are levered which means all you recoup is the initial margin posted and that contributes to the death spiral of having to liquidate assets in a crappy market and only raising 10% of the market value if you’re completely levered. You’re still on the hook for the losses but where will you get cash if every 1 dollar you want to raise only generates 10 cents?
Side Note: Contributing to the problem has been the mass exodus of assets from dealers (who have been forced to delever post 2008) to the institutional/hedge fund community (no real govt oversight of leverage limits). When vol is down, great no problem. When vol spikes and risk models indicates stop outs/need to raise capital, institutional/hf community are forced sellers into the market and without the ability of the dealers to buffer and be that shock absorber for the selling pressure, it creates much gappier markets.
