Block Trades and the Archegos Capital Meltdown
Image credit: Piqsels
Block trades are sales of large large chunks of shares. They change hands at prices negotiated outside of the open market. Block trades are relatively common and most major broker-dealers provide block trading services. A series of high-profile block trades, both in size and magnitude, have cast increased attention on block trading recently.
The New York Stock Exchange (NYSE) defines a block trade as involving “at least 10,000 shares of stock or a market value of $200,000, whichever is less.” Most block trades involve substantially higher amounts than this.
Block trading often occurs outside of the open market. Another name for this is over-the-counter (OTC) trading. OTC trading occurs via a broker-dealer network, instead of on a centralized exchange. One of the reasons for this is to maintain price stability. When investors make block trades on an exchange, the market may experience large price fluctuations. Such price fluctuations could be unfavorable to the institutions behind the block trade.
In nearly all cases, institutional investors or corporations execute block trades. Since block trading occurs outside of open markets, the parties can negotiate a fixed price for the entire trade. This decreases volatility from the traders’ point of view. However, such large sales can trigger instability for the market.
Rule 526 Governs Block Trades
Block trades are privately negotiated transactions. Rule 526 as set forth by the CME Group, provides the regulatory framework for block trading. The CME Group is an operator of numerous exchanges and trading platforms, including the Chicago Mercantile Exchange (CME), The Board of Trade of the City of Chicago (CBOT), the New York Mercantile Exchange (NYMEX), and the Commodity Exchange (COMEX).
Rule 526 provides that parties to a block trade must be Eligible Contract Participants. The Commodity Exchange Act defines the term Eligible Contract Participants. It includes institutional member firms, investment companies, broker-dealers, pension funds, insurance companies, and high net-worth individuals. The Commodity Exchange Act is a federal act that Congress passed in 1936 to regulate commodities and futures markets.
The regulations also mandate that block trades occur at “fair and reasonable” prices. This determination requires a case-by-case approach. Considerations include the size of the transaction, the prices of similar transactions, and the circumstances of the parties to the block trade.
Goldman Sachs and the Block Trades Spree
In late March 2021, Goldman Sachs attracted attention for processing an unprecedented $10.5 billion worth of block trades. Goldman Sacks processed the trades in a condensed timeframe. The identity of the seller behind the series of block trades that Goldman Sachs executed initially was shrouded in mystery. Other investment banks also executed large block trades around the same timeframe.
The $10.5 billion block trading spree erased $35 billion of market value from numerous large U.S. and Chinese companies. This took place within a short timeframe. Observers initially speculated that a struggling hedge fund or family office forced to sell quickly sparked the large block trades.
Shares of Baidu, Tencent Music Entertainment Group, and Vipshop Holdings totaling $6.6 billion in value sold in the block trades executed by Goldman Sachs. Shortly thereafter, $3.9 billion of shares of ViacomCBS Inc., Discovery Inc., Farfetch Ltd., iQiyi Inc., and GSX Techedu Inc. also sold. The block trades caused a slump in the stock prices of these companies.
Archegos Capital Defaults on Margin Call
Soon enough, Archegos Capital emerged as the one behind the high-volume block trading activity. Archegos Capital Management, a fund controlled by former Tiger Management protege Bill Hwang, needed to liquidate positions quickly. Margin calls on highly leveraged positions caused the forced sales.
Archegos broke its silence in an emailed statement: “This is a challenging time for the family office of Archegos Capital Management, our partners, and employees. All plans are being discussed as Mr. Hwang and the team determine the best path forward.”
Archegos Capital defaulted on margin calls by its lenders. These defaults cause those lenders to sell large blocks of shares to recoup what they owned.
Credit Suisse and Nomura Hit Hard
The Swiss bank Credit Suisse and the Japanese bank Nomura were the banks hardest hit by the Archegos meltdown. Credit Suisse announced that it will take a $4.7 billion hit from the Archegos events. The Swiss bank also slashed dividends and fired a number of executives linked to the risky decisions.
The Archegos collapse is the second crisis this year that has caused Credit Suisse huge losses. Just a month earlier, Credit Suisse had to freeze $10 billion in supply chain finance funds. These funds invested in the now insolvent British firm Greensill Capital.
A pension fund filed a class action lawsuit against Credit Suisse recently. it alleged that Credit Suisse engaged in high-risk behavior. The lawsuit claims that the behavior violated federal securities laws and exposed the bank to billions of dollars of losses.
The Bottom Line on Block Trades
The Archegos saga led to heightened public scrutiny of block trading. Nevertheless, block trading remains an important part of the trading ecosystem. Institutional investors, venture capitalists, and private equity firms commonly execute block trades, They may want to sell large quantities of securities they are holding in a company following a merger or acquisition. Block trading allows these institutional investors to sell down their positions cheaper and more efficiently than through regular electronic trading.