Supervisory expectations for large banks’ counterparty credit risk management and margin practices – considering the default and failure of the leveraged fund Archegos Capital Management – were reiterated Friday by the Federal Reserve Board in a supervisory letter.
The letter was addressed to heads of supervision and examination at district banks, with instructions to share with supervised organizations and supervisory staff in their districts.
“Regardless of the type of client, banks are expected to undertake proper due diligence with a client and take fully into account the risks that a relationship with a client may pose to the bank,” the Fed wrote in its Supervisory Letter 21-19.
The supervisory letter states that the failure of Archegos resulted in more than $10 billion in losses across several large banks, mostly outside the United States. “The Board, along with other U.S. and foreign regulators, initiated a review to assess the failure and the actions that led to it and may take further action,” the letter states.
Archegos Capital Management, the Fed said, was an investment firm heavily concentrated in a small number of U.S. and Chinese technology and media companies. The firm defaulted in March, causing, the Fed said, the more than $10 billion in losses for large, mostly foreign banks.
The Fed said its letter is intended primarily for use by banking organizations with large derivatives portfolios and relationships with investment funds, as well as for supervisors as they assess and examine such institutions. “This letter is generally not applicable to community banking organizations and banking organizations with insignificant derivatives portfolios or relationships with investment funds,” the letter states.
The letter lays out three points banking firms should consider:
- Receive adequate information with appropriate frequency to understand the risks of the investment fund, including position and counterparty concentrations, and either reconsider the relationship or set sufficiently conservative terms for the relationship if the client does not meet appropriate levels of transparency;
- Ensure the risk-management and governance approach applied to the investment fund is capable of identifying the fund’s risk initially and monitoring it throughout the relationship, and ensure applicable areas of the firm – including the business line and the oversight function – are aware of the risk their investment fund clients pose to the firm and have tools to manage that risk; and
- Ensure that margin practices remain appropriate to the fund’s risk profile as it evolves, avoiding inflexible and risk-insensitive margin terms or extended close-out periods with their investment fund clients.