Archegos report details margin failings at Credit Suisse

Dynamic margining and a $150,000 software fix for ‘bullet swaps’ could have saved the bank $3 billion

Last August, software engineers at Credit Suisse pitched an idea that would have allowed the bank’s prime brokerage division to periodically raise margin levels for the long-dated equity swaps it traded with Archegos Capital Management. The project would have cost just $150,000 but was never approved. Seven months later, Archegos defaulted, leaving Credit Suisse with a loss of $5.5 billion.

The failure to implement the margin fix was one of several blunders detailed in an independent report cataloguing the reasons why Credit Suisse suffered the worst losses of any bank tangled up in the Archegos default.

Unlike traditional equity swaps, which typically reset monthly, the so-called bullet swaps Archegos traded with Credit Suisse had an average tenor of two years and did not periodically reset to current market value. Credit Suisse applied a static margin charge to these contracts, meaning the amount of collateral Archegos was required to post against its positions remained unchanged in dollar terms regardless of how much they went up or down in value. This left the bank severely undermargined in percentage terms as the gross value of Archegos’s swaps increased three-fold, from around $7 billion in September 2020 to approximately $21 billion at the time of its collapse.

The $150,000 software upgrade would have enabled Credit Suisse to automatically re-calculate initial margin levels for these contracts as the positions surged in value. But the idea was tossed into a “book of work” that was shelved and not funded by the time Archegos defaulted.

According to the report, Credit Suisse held just 9.4% margin against its swap positions with Archegos as of March 23 – two days before the family office defaulted.

Risk.net previously reported that the average swap margin posted by Archegos was around 10%. This was well below industry standards for equity swaps. Most banks set a 15% margin floor on single-name contracts, while concentration limits and other add-ons can push overall margin requirements to 35–40%, a risk head at another large bank told Risk.net at the time.

Archegos’ margins were not always rock bottom. In 2017, Credit Suisse agreed to forgo a 10% directional bias add-on for Archegos’ cash portfolio after the firm argued the exposures were offset by its swap portfolio. The bank caved and removed the charge on condition that Archegos’ combined portfolio bias did not exceed 75%.

Margin levels were dropped again in 2019 when the family office complained that other prime brokers were able to offer lower rates because they had software capable of cross-margining its swaps and cash equities positions. Credit Suisse agreed to Archegos’ demands, dropping swap margins from an average of 20% to 7.5%. This time, the condition was that Archegos’ positions should not become overly concentrated. 

But they did – by March 2021, Archegos’ largest position amounted to more than 8% of the outstanding float, while its portfolio swung between 63% and 95% long from week to week. Despite this, Credit Suisse maintained swap margins at 7.5% and did not reinstate the bias add-on it removed in 2017.

Dynamic failure

By September 2020, Credit Suisse had developed the technology to dynamically margin swap portfolios – either on a standalone basis or alongside cash portfolios. The new system accounted for factors such as volatility, liquidity, concentration and directional bias when setting margin requirements. While Archegos had previously claimed that its swap and cash equity positions were offsetting, the team that built the dynamic margin model estimated that Archegos would need to post $3 billion in additional swap margin if its portfolios were dynamically cross-margined.

There was pushback to this from the business. In December 2020, the head of prime services risk said he didn’t want to move Archegos to dynamic margining because “Archegos preferred to do one thing at a time”. At the time, Credit Suisse was in the middle of migrating Archegos’ swap portfolios from one of its UK entities to another.

When a credit risk manager at the bank demanded a timeline for implementing dynamic margining, the head of prime services risk responded that it was more important to “balance a commercial outcome with risk management”. He said that asking Archegos for an additional $3 billion in swap margin would be “pretty much asking them to move their business”, the report states. 

The head of prime services risk had not held a risk position before, and had previously been the sales lead for Archegos’s swap account. He was approached by the engineering team again in February 2021 with a proposal to implement dynamic margining with Archegos and told that calculations showed this would increase Archegos’ required swap margin by $3 billion. This was not shared with more senior colleagues in risk. Instead, an analyst covering Archegos was told to draft a proposal suggesting that dynamic margining would cost the fund a day-one step-up of $1.3 billion in additional margin. The analyst’s efforts to speak with Archegos were ignored.

This would prove to be a pattern.

This was due in part to a lack of competence (including a failure to appreciate obvious and severe risks) as well as a culture in which profits were prioritised over sound risk management and respect for controls

Independent report on Credit Suisse loss

In March 2021, a senior risk committee met and decided it was finally time to move Archegos to dynamic margining, but that it would only have to post $250,000 in additional swap margin. There was no reason why less than one-tenth of the original amount was decided on – and the report says “the rationale for this particular amount is unclear, although certain participants recall that it was suggested by the head of equities”.

Staff at Credit Suisse scheduled three follow-up calls in the five business days before Archegos defaulted to discuss the dynamic margining proposal. They were all cancelled at the last minute.

Only a week before, Archegos called in the variation margin it held with the bank.  From March 11, Credit Suisse gave Archegos $2.4 billion, all approved by prime services and credit risk management, who did not believe the bank had a legal right to refuse the payment. During that time, Credit Suisse also had the legal right under its Isda agreements to call in the additional $3 billion in initial margin it had calculated Archegos owed, but failed to do so.

On March 25, the day of the Archegos default, Credit Suisse issued two separate margin calls, one for cash positions and another for its swaps, totalling $2.8 billion. On a call that day, Archegos said its cash had been used up on margin calls from other brokers. 

An “event of default” notice was hand-delivered on the morning of March 26, when Credit Suisse had approximately $17 billion in gross exposure to Archegos. Part of this exposure was liquidated in a joint block-trade sale of the Baidu, Tencent and Vipshop Holdings with Goldman Sachs. On March 28, Credit Suisse entered into a managed liquidation agreement with UBS and Nomura. The bank exited the remainder of its positions through block sales and open-market algorithmic trading. 

Goldman Sachs, Deutsche Bank and Morgan Stanley refused to take part in the managed liquidation. 

The report concludes that Credit Suisse’s $5.5 billion loss was caused by a combination of outdated technology, human error and mismanagement. 

“This was due in part to a lack of competence (including a failure to appreciate obvious and severe risks) as well as a culture in which profits were prioritised over sound risk management and respect for controls,” the report states.

Credit Suisse has since implemented dynamic margining.