‘Crypto Dad’ Giancarlo says DLT could have aided in Archegos

Christopher Giancarlo, former top regulator and now blockchain champion, says the risks associated with Archegos Capital Management’s $20 billion default might have been better monitored if the collateral in its trades had been managed using distributed ledger technology.

“A distributed ledger, which all market participants would be on, is the way you could have a comprehensive view of any institution’s activities and all markets, whether it be a clearing house, or a prime broker’s exposure to markets,” says Giancarlo. “The regulators could be ‘nodes’ on that system.”

Archegos, a family office headed by former hedge fund manager Bill Hwang, ran into trouble on March 26, when its leveraged bets on a concentrated portfolio of Chinese and US stocks turned sour. Its use of total return swaps allowed Archegos to escape regulatory scrutiny of its holdings. In addition, Archegos opened positions with several prime brokers who may not have been aware of the extent of credit lines extended to the lightly regulated family office.

Distributed ledger technology (DLT) creates an official, master version of a record of data by a group of participants. The technology also forms the basis of the blockchain system, which underpins cryptocurrencies such as bitcoin.

The information held on the distributed ledger can be accessed with pre-set levels of permission for certain users, and is updated in real time. Advocates of the technology, including Giancarlo, believe it could enable regulators to better monitor the use of collateral and build-up of leverage.

“[The technology] could be useful in situations like this, where you’ve got a family office that is using many different prime brokers,” Giancarlo says.

Giancarlo has been dubbed ‘Crypto Dad’ for his long-standing embrace of cryptocurrencies and the technology that they use. Earlier this month, he joined Baton Systems, a DLT provider working with banks including Citi and JP Morgan on new methods of margin processing.

Giancarlo previously led the US Commodity Futures Trading Commission between 2017 and 2019. Before that, he spent 15 years on Wall Street in over-the-counter, interdealer broker markets. After Giancarlo’s departure from the CFTC, the regulator exempted family offices from oversight measures on two occasions.

Archegos’s use of multiple prime brokers allowed the family office to accumulate highly leveraged positions. In 2016, the CFTC expressed concerns about another practice said to contribute to the build-up of leverage—margin financing—whereby clearing members lend money to their clients to post as initial margin.

Giancarlo thinks DLT would improve the management of collateral, in particular the use of rehypothecation, where firms pledge securities that have already been used as collateral. The practice is allowed but within strict limits.

“This is where I think DLT will be a game-changer because collateral will be verified on a consensus basis, and the chance of collateral re-pledging, double-pledging, triple-pledging will be minimized, potentially to zero,” Giancarlo says.

Left holding the can with defaulted margin calls, banks including Credit Suisse and Nomura are now billions of dollars out of pocket as a result of Archegos’s over-sized bets. Regulators are scrambling to understand how the family office was able to build its positions, and are under pressure to put in place measures to guard against similar blow-ups in future.

At the core of Archegos’s investment strategy was its portfolio of total return swaps. These are contracts where one party receives the total return of an underlying asset, often a basket of equities, in exchange for set payments.

In Europe, total return swaps are reported to authorities under the Securities Financing Transaction Regulation. In the US, firms are not required to report comprehensive data on total return swaps to regulators, but this will change from November when firms will be required to comply with security-based swap reporting rules.

Giancarlo says national regulators such as the CFTC currently lack a real-time system to globally track trading flows. A DLT-based system could help authorities share information, to help build up a picture of cross-border exposures.

“The CFTC looks at an enormous amount of data, but it’s mostly data by either US firms or in US marketplaces. The CFTC doesn’t see daily data about what a US bank, or even a foreign bank trading in the US, may also be pledging in Singapore or Japan,” Giancarlo says.

“Regulators have various pieces of the puzzle, but the degree of sharing of that data is completely idiosyncratic, and to the extent it’s shared, it’s not on a real-time basis. There really is no comprehensive data set in any asset class,” he adds.