Regulation post Covid: Part 1 (71): 13/12 - Post-Archegos reviews

News that the PRA/Bank has ordered UK based banks to undertake a review of their equity finance businesses, following the Archegos scandal back in March, is not a surprise. But the letter itself - jointly from the PRA and FCA - is interesting both for what it indicates about how regulators are approaching the issue and for what it says about the potential scale of the problem.

While the scale of Archegos in terms of losses was fairly evident early on, there was less clarity about how widespread were the risk management problems that it exposed. Since those early days, the tendency has been to view these problems as fairly localised, notably in Credit Suisse, whose independent report, by lawyers Paul Wiess (published in August) revealed a “fundamental failure of management and controls”. However, the regulators' letter challenges this narrow view.

The review it orders must cover a range of broader issues - from business strategy to onboarding and close out, as well as risk management itself, and will need to take in "?all major prime brokerage activity". The coordination with other major regulators is also notable. Credit Suisse clearly had its own set of acute issues, but the overall problem now appears to be much wider.

The Annex to the letter, which sets out the regulators' observations since March, reads as a considerable indictment of current practice, both between and within individual firms. Findings and remediation plans resulting from the review are to be sent to the regulators by the end of Q1 2022, and we should expect this to be an extensive exercise with long-running ramifications. It bears repeating that the problems so far identified indicate, as the regulators admit, that "lessons from the Global Financial Crisis have not been learned sufficiently and that necessary changes to business and risk management practices have not been embedded in firms’ operations".

More than a decade on, this admission is not an obvious endorsement of the quality and intensity of regulation, either prudential or conduct. The nature of Archegos - a family office operating outside the regulatory perimeter - means banks' relationship with it (and other similar entities) would not be a natural focus for supervisors. But most crises originate at the periphery, so part of good supervision is about looking in darker corners. And several of the weaknesses so far identified are much more central and could reasonably have been spotted sooner, especially given the disparities of practice between different firms. If Archegos has exposed potential weaknesses in banks' risk management, then it also raises some questions about the overall coherence and effectiveness of the supervisory model.

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