Approximately during one year period financial markets and investors have faced several quite shocking financial fraud and manipulation cases related with big names of the industry. Seems like banks and other financial institutions in zero rates decade have grown up a tremendous appetite for alternative profit margins and a huge tolerance for risk. Money are still floating free and limitless, what makes the cover up of financial holes way easier than ever before.
The first, recent significant and striking story, has sailed to the surface in an orderly Germany. Giant and exemplary payments fintech Wirecard worth of $ 28 billions went busted with a scam that resulted factually missing $ 4 billions of cash, indicated in balance sheet. The issue is still a hot topic in Germany and specially in watchdog agencies as the fraud lasted for many years and company’s external auditor Ernst&Young didn’t sent any warning signs.
Tolerance for deviations from standard procedures, high audit fees and big margins on financial services, exceptionally reputation based approach and trust, lack of courage to doubt in people who are standing higher on hierarchy ladder, these and some other reasons made this pile of lies and crimes to grow into the problem that moved the fundamentals of financial sector.
The second bankruptcy, according to current available information, is less related to a criminalized fraud but more with an exceptional accounting usage to hide liabilities from the balance sheet and a creation of asset backed securities on the more or less fictional assets. Greensill, a supply chain financial giant, went bankrupt after no insurance company on the globe was willing to provide support for bank’s created supply side invoices backed securities, which were for sale as a secure fund through Credit Suisse. Assets securitization process was so puffed up, that it was based not only on clients sales but also sales expectations. Different schemes to borrow, lend and invest were overwhelmingly mixed up in all Greensill activities. The archetype of trustworthy and honorable person of Mr. Greensill was reinforced with the help of British government, specially David Cameron, and Australian government. The pyramid was growing up very swiftly with the blind trust for big profits for all related parties.
Ultimately, the most recent financial scandal struck the markets just weeks ago. When Archegos Capital, a substantial size asset management family office, no longer was able to keep his extremely highly leveraged business model stable. Archegos was leveraging it’s stock positions with many different financial institutions. Due to the products they used to trade – TRS (total return swap), it was almost impossible to track the exact exposure of bets on stocks. TRS by the nature is a regular derivative product suited to hedge against the stocks volatility. Where one counterparty is paying interests plus a possible spread and another – a stocks performance for the period. As the product isn’t reported as regular shares exposure to the exchange traded stocks, it’s almost impossible to track what size bets are done on the stocks.
It’s still not clear what exact losses will hit involved banks in Archegos Capital activities. However, different financial news predicts them to be in the range from $ 10 to $ 20 billion. The biggest part of losses will be beard by Nomura and Credit Suisse banks. It’s always easy to blame one company for an inappropriate behavior. However this unmanageable leverage and extreme stocks exposures comes from the rest of the sector, which cherish this kind of business and activities.
Big commissions for the transactions and opportunities to do the business with risky funds, drives banks mad. Blind decisions just to keep up with other financial institutions keeps rest of us to wonder, how crazy this righteousness of investment banking can be. These stories emphasis, that even now existing heavy control requirements of central banks are way too small to keep financial sector out of manipulation and fraud troubles.
TRS might become a new troubled derivative product in the near future. With the lack of clear reporting and clarity of the product possible exposures, TRS has a potential to do a big mess, the way in year of 2008 a mess was created by credit default swaps. There are no clear and consolidated numbers of the TRS market size. However, most of the banks are experiencing the growth in a trading of this derivative. As it gives opportunities for the customers to make big bets on equities with relatively small assets back-up, which depends on individual bank requirements. Required collateral for an open position generally is quite low due to harsh competition between banks.
At the end of March of 2021 JP Morgan executed the first fully electronic standardized TRS based on IHS Markit’s iBoxx USD liquid high grade bond index. “Total return swaps have been an efficient tool for investors’ credit hedging and value-seeking purposes for many years, and the electronification of this market should broaden the product to a wider user base,” said Will Haber, head of North America macro credit trading at JP Morgan. Positive thing about this gradual step of bonds related TRS to the broader market will be a foundation not only for a bigger future popularity but as well for clear visibility and possibility to track better the exposure and volumes of the product. However big part of the TRS world based on specific stocks might be still undercover with bilateral agreements for extended period of time.
Financial markets participants open derivatives positions and construct assets backed securities to improve their financial flow processes and hedge the risk they have on balance sheets. However in many cases it’s so tempting to manipulate and extend it to the limit, where collapses are inevitable. Paradoxically that bubble stage is unreachable alone and this collectively shared hunger for manipulated profits is very welcome in all financial industry. Watchdogs are putting as many as possible safeguards but they are always one step behind. Creativity will always be on the side of the thirst, no matter what kind of origin it is.
Should we tackle the issue with an extended personal responsibility frame including a wider circle of possibly related persons? Should we put more focus on topics as market manipulation? Where harmful actions by few are effecting many other participants? Maybe these individuals and companies should bear full financial responsibility for these kind of actions? These and many other possible questions are probably on the table of regulators. However conservatism and caution of regulators not to disturb the markets too much is essential.
Even though, Ernst&Young made big mistakes in it’s primary functions and responsibilities, due to it’s size the audit license question is not on the table. Credit Suisse is a bit embarrassed but still fully operates in all investment services without any legal impact for it’s activities, except some direct losses. Hopefully at some point regulators will focus more on smaller participants of the economy and adequate measures will be taken on mostly influential market players. We should strive for a much more progressive and protective enforcement. Where fraudulent and manipulative activities would threaten the existence of the business automatically and not on the exceptional basis.