Never Mind The Hyperbole, Here Is What Trading Is Really About In 2022

Thus, to quell the deafening silence which, if it were able to be depicted, would only punctuated by the sound of tumbleweed blowing across an empty prairie, there is always a dollop of hyperbole emanating from within to either project a degree of hope, or to afford a metaphorical pat on the back to those who need to feel some kind of achievement when the year ahead’s targets are burning a hole in the paper they are written on.

This year, it is the apparent ‘stress testing’ of the institutional electronic trading industry that is cause for virtual celebration, with many executives lauding how the prime brokerage and Tier 1 bank market makers and interbank dealers overcame unusual and unprecedented market events such as the meme stock phenomenon, the infamous failure of the Archegos hedge fund, the social media-driven crypto flash crash and the Chinese government’s restrictions on education stocks.

These events, however, should not be played down as ‘stress tests’, as that is not what they were at all. They were a form of people’s revolution, and that is why the institutional and interbank dealing sector is now outing itself in the media using heroic terminology and considering itself the means by which every trader and market participant in the world is still on an even keel.

This must be taken with a very large barrel of salt.

Let’s look at all of these events individually and dissect why there has been no evolution for the institutional prime brokerage or hedge fund sector, and why the road ahead is in the hands of innovative retail electronic trading firms with good quality in-house trading infrastructure.

The Demise of the Archegos Hedge Fund

Here is a clear example of the ability of those with a silver tongue to be able to convince large institutions to give them trade clearing relationships and large margin accounts.

Archegos Capital Management was founded in 2013 by Bill Hwang, who was hailed at the time as a ‘superstar’, which is a relatively new and somewhat odd term for a financial industry professional. Back in the early 1990s at the beginning of my career, this type of terminology was reserved for performing artists, whereas good traders were known as, well, good traders.

The contradiction here, however, is that Mr Hwang was not really a ‘superstar’, but an erudite and confident man who was able to convince people that he was.

In fact, he had already had a serious brush with the regulators in the United States at an early stage in his career when he was headhunted by Tiger Asia Management by one of his clients.

Mr Hwang’s journey began when he left his first job in the industry which was at Hyundai Securities in New York, and went to work for Peregrine Financial Group (PFG) which is now famously defunct, itself having been the center of a scandal at the beginning of the last decade, its demise along with MF Global’s equally catastrophic end, being used as one of the main reasons for the Dodd-Frank Wall Street Reform Act having been signed into US law by former president Barack Obama.

Whilst he was working at PFG, one of his customers was Julian Robertson who owned Tiger Management and was subsequently offered a job there.

Shortly afterwards, that hedge fund was closed down, however Mr Robertson gave Mr Hwang around $25 million to launch his own fund, which was given a similar name, Tiger Asia Management, which grew to over $5 billion at its peak.

Tiger Asia Management suffered extreme losses during the recession at the end of the 2000s and in 2012, Tiger Asia Management and Mr Hwang paid a $44 million settlement to the U.S. Securities and Exchange Commission in relation to insider trading, and as if insider trading and a conviction for it was not bad enough, just two years later, Mr Hwang was banned from trading in Hong Kong for four years.

A total blind eye was turned to this, and he was allowed to begin his Archegos Capital Management venture, with some major Tier 1 banks on side in 2012 immediately after he closed down the ill-fated Tiger Asia Management.

So, a pattern is now clear. Mr Hwang’s own ventures had been a pattern of disaster before he began his Archegos venture.

The facts are that by the end of the first quarter of 2021, the losses at Archegos Capital Management caused the default and liquidation of positions approaching $30 billion in value, leading to substantial losses to Nomura and Credit Suisse, as well as Goldman Sachs and Morgan Stanley.

Large positions were open in stocks in North American and Chinese corporate giants at the time. Due to the default, Cedit Suisse exited its prime brokerage business as a result of losing $5.5 billion. Archegos had a 20% share of Texas Capital Bancshares, the firm’s stake having increased by 93% then plummeted severely after Archego’s collapse.

Nobody can possibly say that any of this is an example of good risk management or risk assessment by prime brokerage divisions of Tier 1 banks.

Quite the opposite view would be more appropriate.

Therefore, for prime brokerage commentators to say that this meltdown which caused Nomura and Credit Suisse, two of the largest FX interbank prime brokers by market share in the world, to scale back their prime brokerage offering, is anything other than a monstrous risk management disaster and failure to understand the basic concept of counterparty credit assessment, and certainly is not a good thing which has raised new questions about how effective prime brokerage risk management needs to be.

In fact, this is another good reason why non-bank market makers and OTC derivatives firms with their own dealing desk and good practices are now shining out as an example. It is because of this legacy of allowing multi-million dollar crashes and then picking off trades sent by their own clients by using last look execution procedures or requotes/rejections that alienation has occurred and the retail OTC industry has looked elsewhere and is either concentrating on warehousing trades, known as a b-book model, or passing trades to non-bank market makers which are very much part of the OTC industry and have a much more aligned method of operation.

The Meme Stock Short

Citing the absence of historical data relating to wildly fluctuating prices of certain listed stocks due to the meme stock phenomenon which took place in January 2021 as an excuse for prime brokers and investment managers to have to conduct a reassessment of risk systems is borderline absurd.

In this age of electronic empowerment, online influence is absolutely everything. National governments can be brought down by social media, global conflicts can be inflamed by social media, some of the richest people in the world have become even more wealthy due to their influence on social media – Elon Musk, the world’s richest man being a case in point, but more on that later, and entire new business sectors have come about due to social media.

Therefore, for a Tier 1 bank or large hedge fund to say that it got caught out by a social media-driven movement could perhaps have been anticipated. Anticipation, after all, is part of risk management.

At the moment, over 30 banks and brokerages are at the wrong end of a litigation case in which their customers are taking them to a class action suit over having closed them out of their accounts during the GameStop short in January last year during a period of massive volatility.

This meant that traders were not able to access their accounts or get through to their brokerage and resulted in losses. Many cited platform crashes because of the volatility, but there were some brokers that continued operating uninterrupted.

This, therefore, was not a stress test, but rather a distinct demonstration that this social media-driven market movement caught some of the large firms by surprise and highlighted the prowess of those which continued to operate through that period compared to those which did not.

Cryptocurrency flash crash

Before the middle of 2021, Bitcoin was the prized store of value for its often outspoken proponents and was a polarizing moot point within the electronic financial markets industry.

People either loved it and contributed to its high value or hated it and stayed well clear.

Since Elon Musk, now the richest man in the world, became a rising star having emerged from his image as an eccentric inventor and technology disruptor into a cryptocurrency and social media influencer, Bitcoin and some other cryptocurrency assets have attracted the attention of many formerly very conservative investors.

Like him or loathe him, he is very very smart. Elon Musk did not get rich by selling electric cars. Well, he did, but it did not make him the richest man in the world, nor did it make Tesla get to the incredible level of market capitalization that it has now. What did that was influence on social media and cryptocurrency advocacy.

When that landmark day In mid-2021 arrived and Elon Musk took to his Twitter account to lambast Bitcoin for the perceived environmental damage done by using vast amounts of electricity to mine the cryptocurrency, declaring that Tesla would not accept Bitcoin any longer as a method of payment for its vehicles.

Suddenly, the price of the popular crypto assets plummeted by an astonishing $700 million but of course that is not because you suddenly couldn’t buy a Tesla with Bitcoin, it is because of the power of the statement made on social media by Elon Musk.

He knew what he was doing of course, and in a trend-bucking flurry, people who would ordinarily be very conservative with their investments scrambled to invest in cryptocurrency. They knew that it would be influenced back up again, and sure enough, it was.

Many cashed in. To call that a stress test would also be very churlish indeed. It was not. It was simply someone who understands the power of social media even more than the Reddit board brigade showing the world how he can make himself the richest man by far (officially!) by influencing the markets.

Those who are ready for the year ahead will be looking away from the traditional dinosaurs that have a long track record of getting it wrong, often to the detriment of corporate and private investors and will be looking to themselves for self-empowerment as we are now in the age of the self-made market makers, which are the traders themselves.

Anyone who believes that any of this stress tested the legacy systems is still among the tumbleweed.

There was no stress test, there was simply a democratic revolution in favor of the traders and properly run retail brokers.

Long may it continue.

Andrew Saks, Head of Research and Analysis at ETX Capital