- Jim Millstein of Guggenheim Securities said regulators should look into the prime brokerage business.
- The co-chairman noted that lenders face increased risk when hedge funds use excessive leverage.
- Millstein doesn't believe the Archegos collapse presents a "risk to the financial system," however.
- Sign up here for our daily newsletter, 10 Things Before the Opening Bell.
Guggenheim's co-chairman Jim Millstein believes regulators should keep an eye on leverage in the prime brokerage business at the center of the Archegos meltdown.
In an interview with Bloomberg on Tuesday, Millstein said that the Financial Stability Oversight Council, which was formed under the Dodd-Frank Act of 2010, should "take another look at the prime brokerage business and the kinds of leverage that's being extended both through the derivatives markets and directly."
The prime brokerage business is a bundled package of services offered by investment banks, wealth management firms, and securities dealers to hedge funds that allows them to borrow securities and cash.
Millstein discussed how "regulation T," a collection of provisions that govern margin requirements for retail investors, doesn't apply to family offices and hedge funds.
"Clearly family offices, hedge funds, other institutional investors clients of the prime brokerage business have been able to obtain much more significant leverage than the average investor, and so, and obviously there are risks associated with it," Millstein said.
The co-chairman added that "when you're highly levered against individual names and not terribly diversified you do run a significant risk of an effective margin call."
Millstein said that this type of leverage not only puts hedge funds at risk, but lenders as well. If lenders are unable to liquidate collateral positions or cover derivate exposures fast enough there can be significant losses.
What Millstein is describing is exactly what happened to Credit Suisse, among others, after the recent Archegos collapse.
Credit Suisse said it will have to absorb a $4.7 billion write down due to its Archegos exposure. For reference, the investment bank's total net income for 2020 was roughly $2.9 billion.
The firm has faced significant fallout after its Archegos losses with numerous top execs stepping down including the head of investment banking Brian Chin and the chief risk and compliance officer Lara Warner, as well as Paul Galietto, the head of equities sales and trading.
Millstein also agreed with his colleague Scott Minerd who said that another Archegos-like implosion is "highly likely" moving forward.
When asked if the Archegos blow-up might lead to reverberations for the markets as a whole, Millstein pointed out that there is still "an enormous amount of monetary and fiscal stimulus" in the system and more could be on its way with President Biden's Infrastructure bill.
The co-chairman said he doesn't believe the Archegos collapse represents a "risk to financial stability" based on the relative size of the hedge fund and current market conditions.