Greensill and Archegos – the untimely return of dodgy finance

A UK finance company with prime ministerial connections and an American hedge fund collapsed within a month of one another. Both had questionable business models. How many other financial disasters are about to happen out there? Victor Hill is asking.

The great financial crash, 12 years on

After Lehman Brothers collapsed in September 2008, bringing the entire international financial system to the brink of meltdown, there was a sense that the world had changed. New financial regulation, more rigorous capital adequacy requirements for banks and improved transparency for financial transactions became standard across the world. Banks and institutional investors adopted social awareness programmes; risk management was associated with social justice and green politics. The financial sector had at last become an upstanding global citizen. There would never be another financially induced recession.

Surely, banks would never allow themselves again to be ensnared with the likes Collateralised Debt Obligations (CDOs) – synthetic debt instruments, mostly comprised of sliced-and-peeled mortgages on US residential property, the value of which was in free fall? Surely, the good people of Wall Street and the City – more diverse than ever, younger and cooler – could never resemble the greedy brutes who nearly blew up the world 12 years ago?

And then, last month, the mask dropped. We all became aware again that financial shenanigans can harm us all, with the collapse of UK finance house Greensill Capital and the US hedge fund, Archegos Capital Management. Neither of these financial disasters was as systemically significant as Long Term Capital Management (LTCM) in 1998 or Lehman in 2008 were. But both were unpleasant reminders that maladroit big finance can hurt.

Greensill: To be or not to be?

If Greensill Capital had not had a recent UK prime minister on the board and had not, almost single-handedly, kept alive the flailing UK steel industry, it might have sunk without trace. But instead, in the age when Boris Johnson’s opulent satin and rattan boudoir can rock a once-great nation, the tsunami triggered by this finance outfit’s collapse is only just beginning to hit our shores.

Lex Greensill cut his teeth at Morgan Stanley and Citigroup before setting up the outfit that bore his name in 2011. He was the son of Aussie melon farmers (great CV, in my view) who headed to London because provincial Queensland was too small for him. Supply chain finance was the sexy name he gave to an old financial trade that used to be called factoring. This is the practice of buying receivables from companies waiting for payment for cash at a deep discount, and then pursuing the debtors with vigour. It is a perfectly respectable business line if done responsibly: all the major banks have operated factoring companies for years.

This was never an innovative fintech start-up as Mr Greensill and his backers claimed. Just as Northern Rock claimed to have reinvented the humble mortgage, so Greensill Capital really believed it had revolutionised invoice financing. Both came a cropper. The term structured finance makes me feel nervous. And the misnomer financial engineeringmakes me want to run. It usually means that financial mutton gets dressed as investible lamb.

The really worrying thing about Greensill Capital is that its principal customer was no less than Her Majesty’s Government. Here’s one example. In accordance with the Pharmacy Earlier Payment Scheme, Greensill Capital took a cut for providing bridging finance for private pharmacies while they waited to be paid for medications by the NHS. But why couldn’t the NHS, which ultimately has access to the great government cash machine, pay its bills to hard-working pharmacists on time? Was the NHS ever going to default? And, without giving Lex the melon farmer and his illustrious board a cut in the deal? A Greensill Capital subsidiary, Earnd even secured a deal with the NHS to pay 400,000 NHS staff their wages early in exchange for a commission. Is the NHS really incapable of paying its treasured staff on time? Whitehall does not have a reputation as a late payer so why was reverse factoring necessary at all?

Notoriously, the failed outsourcing company, Carillion, used supply chain finance to hide its debts and deployed reverse factoring to accelerate payments. It even had an accounting category marked prospective receivables. Very few people saw the demise of Carillion coming – though one was my distinguished colleague, Evil Knievil. Lex Greensill used such creative accounting to buy a bank and run four private jets. And it’s not just the UK that has been impacted. German municipalities have about €600 million at risk via Greensill’s German subsidiary. Even the Cologne opera house is now in financial peril.

Then Greensill Capital used the UK government’s various Covid-related loan guarantee schemes to underwrite hundreds of millions of loans to its customers – including Sanjeev Gupta’s GFG Alliance steel and commodities operation – another highly leveraged business which is now tottering as it struggles to refinance debt. GFG Alliance’s subsidiary Liberty Steel employs 5,000 workers in the UK. We now know, thanks to the Financial Times, that CGF Alliance set up new subsidiaries allegedly with the sole purpose of applying for government backed Covid loans. Its accounting practices have been questioned. The relationship between Greensill Capital and CFG Alliance has been the subject of speculation for some time. Mr Gupta’s request for government support has so far been rejected on the grounds that his group’s finances are opaque.

Much attention has been given to ex-PM David Cameron’s attempt to woo the Chancellor and the Bank of England in an attempt to obtain preferential loans for Greensill under the government’s Recovery Loan Scheme. Such loans were not forthcoming. Mr Cameron was an employee of Greensill Capital and as such was just doing his job. Retired politicians are often engaged by financial institutions precisely because they have cabinet ministers on speed-dial. Mind you, Mr Cameron should have asked probing questions about getting the use of private jets and a substantial salary in exchange for 25 days work a year.

What is more concerning is that Mr Greensill himself was retained as a government advisor on supply chain financeduring the Cameron premiership. He even had a Downing Street email address, embossed business cards and a desk within the Economic and Domestic Affairs Secretariat (EDS) which reports directly to the Cabinet Secretary. He had been recruited by the then Cabinet Secretary, the late Sir Jeremy Heywood. Having been seconded to Morgan Stanley a few years earlier (where according to one report he met Mr Greensill), Sir Jeremy was fascinated by financial engineering. It seems that Mr Greensill used this advisory position to promote financial and other products from which his businesses benefited.

Then came the astonishing revelation that the government’s chief commercial officer, a certain Bill Crothers, was simultaneously working as an adviser to Greensill Capital. It further transpired that the former commissioner of the Metropolitan Police, Lord Hogan-Howe, who was appointed to the board of the Cabinet Office in May last year, was also a paid adviser to Earnd. Add to this the suspicion that many of the Covid panic contracts for such things as protective equipment were awarded to charlatans with flimsy connections and the waters muddy further. And what about the £37 billion spent on Test and Trace?

There is a lot of talk of scandal in the UK right now; but what is really on the agenda is the functioning of the civil service and how it can be reformed. As a preliminary to that, the current Cabinet Secretary, Simon Case, has ordered all civil servants to reveal any second jobs they may have. The risk now is that the border between business and the civil service will be sealed to the detriment of both. In Singapore, business leaders are obliged to do a stint in government out of a sense of civic duty. Here, such is the media hysteria, we are in danger of making any contact or cross-fertilisation between business and government taboo.

Archegos: The slings and arrows of outrageous fortune

Korean-born and LA-based Bill Hwang was a legendary trader who was entrusted by investors to run Tiger Capital. In 2012, that fund was charged with illegal trading with Chinese banks from which it had made an alleged $16.7 million in illicit profits. After legal action, the fund was closed. In 2014, Mr Hwang was barred from trading in Hong Kong for four years for insider trading. Thereafter, living in unpretentious suburban New Jersey, he maintained a low profile running his largely family-owned fund, Archegos Capital Management. Reportedly, he turned the initial capital of $200 million into $20 billion in just nine years.

Archegos was taking huge long-term bets on selected Chinese and US tech and media stocks. Mr Hwang favoured taking exposure via derivatives – in particular, total return swaps. These give investors exposure to an underlying asset without having to legally own it. That means that Archegos never appeared on the register of shareholders and therefore corporate governance issues were never raised.

In late March, Archegos hit the buffers. Its fire sale of assets worth around $20 billion caused a major wobble on Wall Street when more than $35 billion of market capitalisation was lost. This arose because Archegos failed to meet its margin calls on its derivatives contracts. Archegos had made a bet on media giant ViacomCBS (NASDAQ:VIAC) – the value of which fell by half last month. The real problem was that Archegos was highly leveraged: in fact, up to 20 times the value of positions according to some reports.

One major lender was Credit Suisse (SWX:CSGN) which was also a major lender to Greensill Capital. The bank has already warned investors that its 2021 Q1 profits have been severely impacted with a gargantuan write-down of CHF5 billion. Nomura (TYO:8604) also disclosed that it was braced for a $2.3 billion hit arising from transactions with a US client, resulting in the bank’s largest quarterly loss since 2008. Nomura warned this week that further losses could arise as positions are unwound. UBS (SWX:UBSG) is also nursing losses of $861 million. Morgan Stanley reported a hit of $911 million. Total bank losses associated with the collapse of Archegos are estimated at $10 billion^[i].

Investors who buy bank shares might be dismayed that their profits from good old retail and commercial banking can be wiped out by a flutter or two on exotic investment houses. Swiss banks in particular have form in this arena. For a start, they make a large portion of their profits from private banking – or, to use the modern euphemism servicing high net worth (HNW) individuals. In so doing, they often get dangerously entangled with family-controlled investment vehicles. Know your customer? Evidently not always.

The sea of debt

These financial disasters took place at a moment when default rates generally are beginning to rise. We all know about the relentless increase in debt on the part of governments in the developed world, with the UK now nearing a debt-to-GDP ratio of 100 percent – the highest level since the early 1960s. What is less well understood is that corporate debt has also ballooned during the pandemic.

According to S&P Global Ratings, businesses across Europe face €1.8 trillion of maturing debt over the next four years, of which €290 billion this year. S&P reckons that the default rate in the UK and Europe stood at 5.4 percent in February – more than double the level of twelve months earlier. Unsurprisingly, department stores, cinemas and restaurants were the sectors with the highest default rates. Companies have sought to take out loans from governments at preferential rates in addition to their bank debt. The fear is that default rates could spike if government loan schemes are withdrawn too quickly. Solvency ratios (essentially debt to equity) are at historically high levels. It is now likely that the loan guarantee scheme is going to cost the UK government (or rather UK taxpayers) dearly.

While low interest rates have helped companies’ coverage ratios, the recent rise in bond yields could cause the cost of debt to tick back up. Highly indebted companies tend to invest less – and that puts a brake on long-term growth rates.

The Greensill and Archegos sagas reflect the frantic trading in the first quarter of this year when social media-organised investors took collective positions on stocks such as GameStop (NYSE:GME), often with borrowed money. US investors, both institutional and retail, are more leveraged than ever in the light of fulsome government spending, quantitative easing, a successful vaccine rollout and the prospect of a rapid recovery.

Both Greensill and Archegos are the result of the near-zero interest rate environment in which aggressive investment outfits desperately seek yield through alternative means. The reckless propensity of respectable banks to lend to the likes of both suggests that a substratum of bad debt may already have been laid – and is yet to be revealed. The longer the artificially created era of ultra-low interest rates persists, the longer the danger of dodgy finance will persist.

And the bigger the state the more scope there is for crony capitalism. When state expenditure accounts for 54 percent of GDP – as was the case in Britain last year – businesses best thrive because of people they know in government. If only someone would whisper that in Joe Biden’s ear. 

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Back in the day, Tony Blair was accused of conducting sofa government. Critical decisions were taken in unminuted meetings by men (they almost always were men) lounging on soft furnishings. Today, we have something even worse: government by WhatsApp. WhatsApp is a sloppy and highly insecure form of communication and ministers – especially prime ministers – should avoid it.

Personally, I don’t seem to receive any personal emails anymore – only WhatsApp expostulations from friends and family, usually accompanied by emojis – as if to express happiness one has to display a happy face. I regret that. A well crafted and properly punctuated email can be an effective tool in business and a pleasure to receive from friends. If you make the effort to set out what you think and feel about something in written language, you understand the parameters much better. Emails are also easier to store, classify and find.

I’m quite sure Lady Thatcher would have agreed with me.

^[i] See: https://www.theguardian.com/business/2021/apr/27/nomura-and-ubs-latest-banks-to-reveal-impact-of-archegos-collapse?CMP=Share_AndroidApp_Other&fbclid=IwAR043M32xUJ067bnjMJybgsBfTNB4ItD7BYrnn7F2Hygl9tc9fhmsRy6aXw