Archegos is the first big scandal to hit the family office sector, a newish industry built to serve the needs of billionaires. The impact will be huge, say insiders, as banks and regulators turn against family offices, and family offices turn in on themselves.
The firm was created by Bill Hwang as a family office, essentially a private company to manage his wealth. But despite his own millions, Hwang borrowed heavily from banks to build up large stakes in public companies such as Viacom, Farfetch and Vipshop.
But when their share prices fell, banks called in their loans and Archegos defaulted, starting a domino effect that has cost nearly $20 billion to date and caused Archegos’s own insolvency.
The dominoes have not stopped there, however. Banks plan on settling scores with many of their family office clients, and regulators are preparing clamp down on the rouge industry.
This is creating turmoil within the family office sector, with the more cautious types blaming Archegos and other large family offices bringing about some very unwelcome changes.
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“That sort of money can do some real damage, whereas you can have a small family office that’s not really going to do anything,” says Chris Cottorone, who heads research for a foreign single family office and is a private equity committee member at AmCham Taiwan.
Smaller and more traditional family offices are generally very careful about ensuring the wealth they look after lasts to the next generation, he says. This means they are much more risk averse.
Archegos, on the other hand, leveraged positions by multiples in order to build up large holdings in single stocks. “I don’t think it’s common for family offices to take such an aggressive strategy,” says Tayyab Mohamed, co-founder of Agreus.
However, there are more and more of these “aggressive” family offices entering the market. Archegos was simply one of a long line of hedge funds which, after returning their clients’ money, rebranded themselves “family offices.”
“There was a spate in the 2000s and 2010s of successful hedge funds in the U.S. primarily closing their doors to external money and restructuring as a ‘family office.’ They typically continued to trade the same strategies,” says Dr Michael J. Oliver, co-founder of Global Partnership Family Offices.
For regulators hoping to prevent another Archegos scandal, this presents serious problems.
How To Stop Another Archegos?
Family offices are able to make bold investments because they are not regulated in the same way banks are.
This can make their returns much more lucrative. In 2019, before the pandemic struck, family offices were seeing an average return of 13.8%, according to a report by UBS, far above what most banks could offer their clients.
How did they perform so well? Most invested about a third of their assets into alternative investments, an area that promises both higher risk and reward. Other family offices teamed together on “club deals” to buy out medium sized businesses.
This is high stakes stuff, and regulators are spooked that it could cause another Archegos-style collapse.
“There’s a lobby now for increased regulations for family offices which is contradictory to every fabric of their DNA because family offices by definition don’t want to be regulated and they want to have discretion and privacy,” says Mohamed.
On Thursday 8 May, the U.S. Federal Reserve warned that “measures of hedge fund leverage may not be capturing important risks,” in a comment aimed at Archegos-style firms.
It was the first hint from a major regulator that it was looking into the issue of family offices. Since then the European Central Bank (ECB) has made comments about further regulation and the U.K.’s Financial Conduct Authority (FCA) has said it will look closer at “non-banks.”
Unfortunately for the regulators, “non-banks” is about as close as they can come to defining what a family office is. The term is banded around in finance circles so loosely that few know exactly what one is anymore.
Nobody even knows how many there are in the world. Campden Research has estimated 1,700 but others expect many more.
Nor are any two family offices the same. Research by UBS last year found the average family office managed $1.6 billion. But while some invested actively in volatile markets, others merely keep the money safe for future generations.
“We hope that the SEC will not bundle both of these situations into a single classification and that two types of family offices can have different regulations and filing requirements,” says Sara Hamilton, the CEO and founder of the Family Office Exchange.
Banks Grow Cautious Of Family Offices
But so much money has proved irresistible to banks. For years, private banks have courted family offices with special departments dedicated to serving their every need.
Family office clients would be offered access to investment products off-limits to normal private banking customers and they could benefit from favorable loans, which is how Archegos came to leverage such vast amounts.
Credit Suisse, UBS, and Morgan Stanley say they are now reviewing their family office divisions. Each of them declined to detail exactly what changes might be in the works, though Credit Suisse, which lost the most to Archegos’s fall ($5.5 billion), said it is “conducting a review of the Group’s business strategy and risk appetite.”
“Bankers are suddenly starting to ask family offices ‘What do you do? How do you invest?'” says Cottorone.
This means that loans or risky investment products might be less forthcoming. Combined with tighter regulation, that could dampen risk appetite and returns.
That might not be a good thing, however, given the silent role that family offices play in society.
Multi-generational family offices are “uniquely positioned to drive change across many sectors and we have seen an unwavering and momentous shift towards ‘building impact’, whether from philanthropic activities, impact investing or increased social and environmental responsibility.” says Oliver.
That responsibility even extends to finding a way out of the pandemic. It was a family office called Athos Service that stumped up the cash for BioNTech to create the world’s first Covid-19 vaccine.
“Family offices are one of the biggest investors out there; they create liquidity for a lot of start-ups, a lot of innovative ideas,” says Mohamed. “The more family offices that are out there that’s normally good for the economy in terms of investment.”