Market Watch Ep.10: Archegos default & Deliveroo IPO disaster

Welcome to the Market Watch podcast by Amplify Live, where you can access the latest market insights with me, Anthony Cheung, the Head of Market Analysis, and joined by our Head of Trading, Piers Curran, getting you up to speed on what mattered in markets this week. Hello and welcome to the latest Market Watch podcast, Amplify Live. It's Thursday the 1st of April, so Piers, we are recording this ahead of Good Friday and nonfarm payrolls, but the episode is going to go out on Friday, just so you're fully up to speed. But episode 10, Piers, can you believe it?

Yes, double figures. And to mark the occasion, I'm actually— this is the first time either of us have been broadcasting from the office. So I'm actually here in the city, bang in the action in London. I say in the action. It's not much action still. But it's nice to be here. Nice to be in the office, I have to say.

And with your return to the office, the S&P 500 has just hit 4,000. Absolutely. Obviously, it was tracking your movements.

That's right. Global stocks bullish as Piers Curran returns to the office. That's the headline in your FT tomorrow morning.

Well, look, there's kind of two main things I wanted to focus on in this specific episode. And I wanted to talk about really the two main talking points, and that being Archegos Capital Management and what's happened specifically there. Definitely a focal point for the beginning of the week. And then midweek, yesterday, we had a disastrous debüt from Deliveroo in London. I just wanted to get your thoughts on that as well. To kick things off, let's talk about this Archegos Capital. I can't say I've heard of them before this week, which is such is the nature of our jobs that I've always found interesting through my career is that, look, there's so many funds, there's so much news, there's so much information. That every day is different. This was one of those episodes, I think, where the broader market was a little bit unknown. A bit of context. This funding question was run by a chap called Bill Hwang, who is one of several tiger cubs. Now, that's going to sound slightly strange if you are not familiar with the hedge fund community, for example. But these tiger cubs come from Tiger Management, which dates back a little bit. It was run by a very famous fund manager back in the '80s and '90s called Julian Robertson. And he wound that up basically in around 2000, but then he invested roughly around $25 million into his cub, who was Bill Hwang. And he went on to grow that, his own fund, up to around $5 billion actually at its peak. Having had a bit of a chance to find out a bit more, he seems like quite a colorful character in terms of his background. He basically went on to build up a pretty successful fund of his own, as I said, but then he pleaded guilty to insider trading in 2012. He had to hand over about $60 million to settle related charges, and he had to close his fund. He was also banned from trading securities in Hong Kong for 4 years in 2014, separate issue. And now then he basically converted what was called Tiger Asia into a family office called Archegos in 2013. So that's how we arrived at this particular fund. So what happened though was last week we saw that fire sale by Prime Brokerage clients for $20 billion. And this week, we've seen then that resulting in multiple billions of dollar hits for the likes of Nomura and Credit Suisse. But perhaps, Piers, you could explain a little bit about what is this $20 billion stock sale, and what is a margin call?

Right. Well, firstly, a lot of these big banks will have what's called prime brokerage divisions. Really, these divisions, their clients are hedge funds, and they offer every service you could possibly imagine that a hedge fund needs. A lot of that service involves financing, it involves stock lending, and more and more and more, it's involved clever— well, I say clever, not so clever now, but complex innovative financial solutions. One of these products is something called the equity total return swap. It's just a derivative that enables the hedge fund to essentially gain exposure to certain assets, but without having to actually own the asset. The great thing about derivatives— one of the good things, I mean, it's a bad thing if you can't control it, but one of the good things is you can get more leverage. So you can basically multiply— it's a multiplier effect in terms of your exposure to the stock. So Archegos were basically wanting to take big, long positions in certain US stocks. But instead of actually just buying the shares, they've used derivatives to leverage up their exposure. And so they've gone to a bank and their prime brokerage division. And the prime brokerage division at the bank has has kind of done an over-the-counter deal. This is a bespoke deal between the fund and the bank. It's an equity total return swap, which basically means that the product means that the fund profits if the share price goes up. The fund also gets dividends from these stocks without owning the actual equity. Then the bank will essentially pay the upside on share price. They'll pay the dividends periodically to the investor. And the investor has to pay a fee, right? So the banks generate a fixed income. It's a fee every month for this product. Now, this is fine, and it all works apart from the fact that if the share prices drop, then the fund has to then refund, reimburse the bank for that share price drop. OK. Now what the bank does is they what's called hedge this position. So the bank will typically buy these shares and have them on their book as a hedge. OK. And then they're earning a fee from the fund. OK. And the fund benefits if the stock goes up. Fine. And they get the dividends. But if the stock goes down, the bank doesn't lose because the fund has to pay them for that downside share price. OK. All fine on paper. However, what you've now got is what's called counterparty risk. This is all fine on paper unless the fund can't afford to pay the bank for the share price drop. And this is what happened, because Archegos basically didn't just go to one bank to enter into this arrangement. They went to many banks. And they entered into massive arrangements with all the banks. And no one bank knew they'd done that with other banks. And all of a sudden, you've got Archegos that are massively exposed to certain US stocks. They start going down. All these banks then request a margin call. That's, Archegos, you need to now pay us to cover this downside in the stock price. And Archegos are like, ah, sorry, we haven't got enough cash. And they default. And so when they default, all these banks are now just holding the shares. And the share price is dropping. And they're losing money, and they're losing money. So the banks are forced to sell these shares. And because it's such a massive position, the sell volume is huge. And it just exacerbates and drives the move downwards. And of course, then you're getting algorithmic trading systems whose stops are getting triggered, which is triggering more selling. And you suddenly get this spiral down. And all of a sudden, all these banks have lost huge billions of money because they were too exposed to counterparty risk. And they weren't able to measure that risk. Because of the way the system works at the moment.

So should we be too surprised by banks partaking in this type of activity in this type of environment?

So I think this is definitely a function. And it's been happening since the financial crisis— well, probably for the last 20 years, basically. As regulation increases on the banking system, and as the yield curve has flattened— and don't forget, traditionally, a bank makes money by borrowing on the short term and lending on the long term. This is the old traditional format of that bank, that lending book making money. But if the yield curve's flat, the difference between the short-term and long-term interest rates is tiny. So their margins on their lending books have vanished. So these banks have had to be clever about coming up with innovative ways to try and make money. But the regulator and the yield curve has basically forced them— these new ways of making money come with ever-increasing risk. And it's risk. These products become so complex that the risks are almost impossible to keep tabs on and measure. And all of a sudden, every now and then, oops, you get smashed in the face because you haven't measured the risk properly on this new thing. And then we get an episode like we did on Monday.

Yeah, it was interesting on Monday. There was kind of a sense of how much more was there to unwind, so to speak. But seemingly, it was relatively contained. Looks like most of that price action actually occurred last week. And It's just been much more delving into how and why this happened this week. But let's move on to the other big subject of the week. And I know it's something you mentioned on the podcast episode last week, and you were eagerly anticipating the performance of Deliveroo, which initially opened, it was down 31%. So talk to me, what went so wrong with Deliveroo?

Yeah, well, it's easier to answer what went right. Because nothing is the answer to that. I mean, literally, if I was writing a case study for the worst possible IPO, this is it. I mean, there's quite a few elements that go into an IPO process. And literally all of them, they got wrong. I mean, it was quite shocking. But I mean, just to very briefly— I mean, we could talk about this for like 2 hours. But just to briefly go over the different elements, Fine, you've got a company, and they want to go public. And they're raising money. And look, they raised £1.5 billion. So Deliveroo have got their money. £500 million of that is going to investors, like the CEO, but also actually the biggest investors. Do you know who the biggest investor is? Do you know who's walking away with £90 million of this money? No. One of the early investors in Deliveroo? Amazon.

OK. Yeah.

Anyway, £500 million going out. So Deliveroo have got £1 million now. And they're going to be investing that in their growth. And we'll talk about the Deliveroo business model in a minute. But really, the timing of this IPO was shocking. I mean, they couldn't have timed it worse on, I'd say, broadly two fronts. Number one, obviously, their business has thrived on lockdowns, because we're stuck at home, and we're having to order food online. And we're just emerging. We're literally just emerging from lockdown. So it's like Deliveroo, they have their positive— their business model, if you like, peaked during COVID And now it's kind of on that downward trajectory. And you can look at DoorDash. That's the US equivalent, who IPO'd last year. They had a really successful IPO. Because why? Well, we're in the middle of COVID And wow, yeah, everyone's ordering from home. Great, this makes sense. I'm going to buy those shares. And their shares went up. Great. But actually, DoorDash They have dropped 30% as well from their peak over the last few months. So the timing's really bad. The other bit of the timing point, 31st of March was the day they chose to IPO. The final day of the month, the final day of the quarter. We touched on this idea of rebalancing in last week's podcast. Do you think that funds are going to touch, buy new shares in what could potentially be a very volatile day right at the end of the quarter when they're rebalancing their books and they're having to report on their quarterly performance. That was me.

So hold on a moment, though. You had Goldman's JP would deliver his joint global coordinators. Bank of America, Citi, Jefferies, UBS acted as bookrunners. They can't get that last point wrong, surely.

I honestly, I cannot believe. I mean, they could have literally just waited one more day. If they'd have done it today, the share price wouldn't have sold off as much. It would have sold off more. Sorry, it still would have sold off because of all the other reasons why this is a bad IPO. But it just got exacerbated. I mean, it literally— I cannot believe these people picked the 31st of March. Anyway, that's one thing. You then got a load of short sellers coming in. OK, now think about how you short sell. You need to borrow stock off banks, right? Obviously, Goldman's and JP, who are leading this, they're not going to allow their clients to short sell. Then you got a load of other banks that aren't involved. Of course, they're incentivized to make JP and Goldman's look really bad. Of course, they're very happily lending out their new Deliveroo shares to enable their hedge fund clients to go short. The hedge funds want to go short because, hang on a minute, we're just coming out of lockdown. No one's going to be ordering Deliveroo in the months ahead, because we all want to go out to the restaurant. So you've got the shorters coming in as well. Then you've got on top of that the whole ethical angle. And you have some big UK funds coming out earlier this week and in the last week saying, we're not touching this. And we're not touching it because 1/3 of your riders, your staff, earn less than the minimum wage. And in this day and age, we are not prepared as a fund manager in a world where ethical investing is becoming an ever bigger thing, we're not prepared to invest in a company that treats its staff in that manner. And so obviously, that was another thing. Final point, the CEO wanted a dual share class structure. All right? Now, this is kind of— he wants to be a US tech firm. So if you think about the Googles and the Facebooks, they've got this dual share class structure. And the US listing process allows for that, and it's quite normal. Here in London, it's been quite restrictive. But this dual share class structure means that he, the CEO, he retains all the voting— not all, but most of the voting power. So he stays in control of the company's trajectory and direction. But the problem with that is you're not allowed in the FTSE 100 index if you've got a dual share class structure. They're the rules. So actually, because he wanted that, it meant that Deliveroo, even though they're big enough on a valuation point of view to be in the FTSE 100, they are not. If he had scrapped the dual share class structure idea, they'd be in the FTSE 100. And what would have happened is you'd have got all the sort of passive tracker funds having to buy Deliveroo shares, which of course would have propped it up, and you wouldn't have seen the sell-off. So that's just a few reasons as to why this is a shockingly bad IPO, in my opinion. And we'll be talking about it for years, just in terms of an event. Whether Deliveroo, are they going to survive? I mean, I don't know. They've got a million pounds in the— sorry, a billion pounds in the bank now to invest in their growth. And it's a super low margin business. And I'm sure they'll be fine. But as an IPO event, wow. Just, I'm speechless.

I don't ever think I've heard you this enthusiastic about a subject in a long time, Piers.

I just can't believe it. And so reputational risk. JP Morgan and Goldman's, what happens to them? Well, all right, firstly, they've lost money because they had to underwrite this, which means that they're propping up— they're trying to prop up their share price yesterday. And the share price dropped, and then it went back up. And that's kind of them kind of just propping it up. And then it's dropped again. And look, they've lost a lot of money here. But from a reputational point of view, All right, look, they're massive banks. And look, this doesn't mean no one's ever going to touch them again. But if I was a tech— if I was a founder of a tech firm who wanted to IPO, then I would not be knocking on Goldman's door or JPMorgan's door at this point, because what they just did shows some pretty basic errors in my mind. So I'd be looking for some of their competitors. Who have driven successful IPOs. Look, there's a short-term reputational damage for sure, but look, they'll get over it.

Okay, great. Well, look, with that, let's just wrap it up with a few points for next week. But even before then, even though it's Good Friday tomorrow, as we're recording this, but as this podcast goes out, there is actually nonfarm payrolls coming out. It's a bit of an unusual scenario. I've checked with the CME futures. Globex trade is going to be open on reduced hours. So the markets will be tradable to that extent. But I think if there is any traders listening, I would strongly advise that you just enjoy any sunshine that there is and the Easter break, because the conditions are not going to be particularly productive, let's say, for intraday trading. But in terms of nonfarm payrolls in itself, we are expecting actually a pretty strong figure. I think consensus estimates is for 650,000, unemployment expected to drop to 6% from 6.2%. We look at the kind of employment indicators that we get that front run the labor report. And we had ADP private payrolls earlier in the week, 517,000 was a 6-month high. I guess not a lot of this though, Piers, comes as a surprise, really. I mean, the kind of Biden relief package in early March, several states easing coronavirus-induced restrictions, and the rapid pace of vaccinations— I mean, you can't be too surprised by the fact that the jobs market is picking up, surely.

Yeah, absolutely. And we're just going through these ebbs and flows where the economic forecasts look strong and keep getting revised higher because of those facts, as you've said. And then we have a bit of a panic about yields every now and then. But in the main, I'm just watching the S&P. It's making a new high literally as we speak. And that's reflective of that fact. The underlying economic situation in the US is looking pretty positive. And so that's being reflected out there in the stock market.

OK, and just a quick look ahead to next week. Obviously, I'll deliver the global macro briefing on Tuesday that will go out on the Amplify Trading YouTube channel. So do check that out. But other things to look forward to next week, yeah, you do have, um, the pretty quiet Monday, Tuesday. You get the Chinese service PMI, you got the RBA, the Australian rate decision. Uh, Wednesday you get the Eurozone, UK service PMI data, US trade balance. Thursday pretty quiet, Chinese inflation data coming out. Friday with US PPI. And that's your wrap. So episode 10 in the bag, Piers.

Well done.

I will see you— well, actually, when will I see you? Not in person in London for another few weeks, I'm sure. But I'll see you on Zoom, let's say.

Enjoy your long weekend.

Yeah, you too. All right, take care.

Thanks, everyone.