- Banks lost billions in the wake of the Archegos scandal, including UBS reporting it faced an unexpected $774 million in losses
- Family office insiders said they are forced to look at alternative options for prime brokerage and custodial relationships
- Regulators in the UK and US are working out how to gain more oversight into this secretive world
- See more stories on Insider's business page .
A few months ago, bankers from the world's largest institutions were devising creative strategies to ingratiate themselves with asset managers and communications firms within the family office nexus. After all, it would be hard to find someone in the financial industry uninterested in tapping into this $6 trillion global asset pool that is largely unregulated.
In the last six weeks, a deal worth $500 million fell through for a large family office that was looking to diversify its custodian base and prime brokerage connection, according to Vikash Gupta, co-founder and managing director of VAR Capital. His firm -- which is an independent family office and asset manager overseeing over $1.4 billion in assets for its client base that hails from Europe, the Middle East and Asia -- is responsible for overseeing and managing big banks' relationships with clients, including this family office.
"This American bank told them outright that we're not taking on new clients and we're managing the clients that we have already and [will] make them more conservative," Gupta said. "So it was quite a shock to the existing family office because they are a proper professional outfit"
As a result, Gupta said he's working with the family office to look at alternative options.
"There are a lot of tier-two banks who don't have enough family office business," he said. "So, we are now looking at other custodians who might be moving into this space. We're happy to talk to them."
In the wake of the Archegos scandal, the lid has been lifted on this secretive world. After decades of operating with scant regulatory oversight, lawmakers and consumer advocates are putting pressure on governments to keep a closer eye on the deals family offices are involved in, especially those businesses operating in capital markets.
Late March was a moment of reckoning for the industry as famed hedge fund manager Bill Hwang's Archegos Capital Management hit rock bottom - once spinning assets of $200 million in 2013 into around $20 billion this year. The firm that was not on any regulators' radar used a highly leveraged portfolio that was concentrated in a few stocks.
The obscure, but seemingly profitable fund, also led to an embarrassing barrage of criticism for the large banks that enabled Archegos, including Morgan Stanley, Credit Suisse and Nomura. UBS reported it faced an unexpected $774 million in loss from the collapse of Archegos, bringing the total loss to the banks that were involved with the fund to $10 billion.
But the pain extends beyond the balance sheet to wider reputational damage, leading Wall Street reform advocates to call for greater scrutiny of the banks that facilitated these deals.
Well-heeled angels among us
Despite a wider acceptance that the days of light-touch regulation have passed, the industry isn't giving up without a fight.
"The lobbyists are all over Washington already for the family offices,'' according to Dennis Kelleher, co-founder, president and CEO of Better Markets, an independent, non-partisan organisation that advocates for the public interest in financial reform.
"When you listen to the lobbyists, you would think that family offices had glowing halos over their heads. And I'm sure that's true for some of them, but it's not true for all of them," he said.
During Donald Trump's presidency, Kelleher argued the industry had found a sympathetic ally that reinforced their protections.
"The Trump regulators at the CFTC [Commodity Futures Trading Commission] even exempted family offices from what's called a statutory disqualification," he said.
Kelleher said this enabled family offices that were engaged in derivatives and commodity trading to be exempt from registering as Commodity Pool Operators (CPO).
Normally, the SEC (US Securities and Exchange Commission) rules would also require "bad actors", such as those who have committed embezzlement, forgery or fraud, to be registered with the CPO, he said.
But the Trump administration amended the rules, exempting family offices players from registering as Commodity Pool Operators (CPO). This would allow someone who is applying for a job with a family office to not disclose past legal infractions. Even if a family office did its own rigorous due diligence, they could still be unaware of a candidate's background.
"You have now unleashed, basically, a criminal on the financial markets and that's going to impact other investors and markets," Kelleher said.
Still, he acknowledged these outliers are not representative of the many employees of the family office industry.
"If family offices are what they claim to be, which is wealth preservation and patient capital... they're going to end up doing some very minimal filing that will cost them almost nothing," he said.
Similar to the US, the conversation around a regulatory crackdown continues in the United Kingdom. The Financial Conduct Authority (FCA) declined an Insider interview request, but pointed to recent comments from Chief Executive Officer Nikhil Rathi to British lawmakers on May 12.
At the hearing, which largely focused on the collapse of Greensill Capital -- a financial services company whose breakdown cost taxpayers £5 billion and brought former prime minister David Cameron into the limelight for his intensive lobbying efforts -- Rathi discussed Archegos.
"The Archegos failure is another major failure of a family office that has been in the news," he told the members of parliament. "I think that also points to the need for some discussions around how reporting of these transactions, how family offices and how some of these hedge funds work across borders as well. I am sure we will want to make progress on that this year too."
Not as simple as it looks
It would be easy to look at the intentionally opaque family office world and blame them for their own undoing. But the story is more nuanced, and industry insiders maintained that Archegos is an exception.
"In terms of the regulators, I think they'll fudge around the edges," said Jordan Greenaway, managing director of Transmission Private, a firm that provides reputation and crisis support to ultra-wealthy individuals and family offices.
He said regulators will make some changes around disclosure "that really makes no difference," but that won't fix the problem of over-leveraging, even if the family offices are forced to report when they're investing in the capital markets. Part of the problem with Archegos was the firm had been allowed to borrow far more capital - known as leverage - with which to trade than it had on its own books. When its positions fell in value, the firm's lenders were forced to sell its holdings, even at a massive loss.
In the Archegos case, you had an individual with "a huge appetite for risk," he said. "You had a coterie of banks who were desperate, desperate for income. Desperate so much that they weren't willing to ask the difficult questions."
He said the real change will come from the banks "whose fingers have been burned" to demand more oversight before facilitating these deals.
"We've had two family offices who've been asked specifically to provide guidance to the bank who asked around what their risk management processes are - because the banks are completely oblivious and unaware at the moment," Greenaway said.
There's also a social role that family office players say they hold. Given their larger risk appetite and major pools of private wealth, they can support beleaguered businesses by focusing on long-term growth, in comparison to venture capitalists or hedge funds that tend to look for more immediate gains.
With an estimated $6 trillion global asset pool ready to be deployed, family office insiders feel they are the balm so sorely needed in the face of the COVID-19 pandemic.
"There are companies, private companies, that are hurting," Greenaway said.
He added: "We have all that stored up private wealth and private capital that can be deployed to give these companies a lifeline."
Via PakApNews