When banks then significantly increase margins at the eleventh hour, as seen recently in commodity markets, clients then have to smell the coffee and scramble around to find the cash. And to be clear, those clients should not be expected to be able to find such sums at short notice. This is true in any market, not just commodities. Initial margins should be calibrated appropriately in peace time to reflect forward-looking risks. Archegos, nickel: these episodes left a few banks with bruises (some quite nasty) or just embarrassment, but not much more. However, the window for investment banks to finally learn counterparty risk management lessons properly is closing fast. And next time – in choppier waters – those who still haven’t may well not be able to get away with only a few bruises. It is important that these market and counterparty risk lessons are finally learned, especially for business lines that have grown on the back of the post-crisis macro environment – such as clientsupporting financing businesses in liquid products (in businesses such as prime brokerage and client clearing) as well as less liquid activities (for example structured equity autocallable note issuance; or Collateralised Loan Obligations, Asset Backed Securities and mortgage loan warehouses; or private credit markets). None of us have a crystal ball, but the waters we find ourselves swimming in are certainly more challenging already.
It is disappointing that lessons from the crisis on counterparty risk management were not properly learned. As we set out in our Dear CEO letter last year, Archegos is a prime example of this – a single client of many firms had built up risk concentrations that proved to be outsized. Some banks also got caught by this in the nickel market more recently. In other cases, we have seen groups of clients with similar risk exposures, whether that be large concentrated positions of their own or trades with banks that held such positions, which proved difficult to exit as market conditions and liquidity dynamics changed. Risk concentration should not only be assessed on a client by client basis, but across all clients combined. And most importantly, across the client’s market-wide portfolio, not just the portion held with a single firm itself. Whilst this information may not be readily available, the onus is on firms to demand of their clients the information they need to assess the risks they are exposed to. We also see some firms not adequately assessing the liquidity position of their counterparties. Look at the “Dash for Cash” in March 2020 or recent issues in the commodities markets. Whilst counterparties may be fully hedged against capital losses from sharp moves in asset prices, some have found difficulty in monetising their assets in order to meet margin calls.