Harvard Case - Credit Suisse's Involvement in the Archegos Collapse: Risk Management and Internal Controls
"Credit Suisse's Involvement in the Archegos Collapse: Risk Management and Internal Controls" Harvard business case study is written by Matthew Sooy, Artika Pahargarh. It deals with the challenges in the field of Accounting. The case study is 10 page(s) long and it was first published on : Feb 28, 2023
At Fern Fort University, we recommend a comprehensive overhaul of Credit Suisse's risk management and internal control framework, focusing on strengthening prime brokerage operations, improving client due diligence, and bolstering risk oversight. This includes implementing a robust system of checks and balances, enhancing transparency and accountability, and fostering a culture of risk awareness throughout the organization.
2. Background
This case study examines the collapse of Archegos Capital Management, a family office that utilized leverage to invest heavily in a concentrated portfolio of stocks. Credit Suisse, as Archegos' prime broker, provided significant leverage, allowing Archegos to amass a large position in a few stocks. When these stocks declined sharply, Archegos' margin calls exceeded its available capital, leading to a default and significant losses for Credit Suisse.
The main protagonists of the case study are Archegos Capital Management, led by Bill Hwang, and Credit Suisse, a global financial institution. The case highlights the risks associated with prime brokerage, the importance of effective risk management, and the consequences of inadequate internal controls.
3. Analysis of the Case Study
This case study can be analyzed through the lens of risk management, corporate governance, and internal controls.
- Risk Management: Credit Suisse failed to adequately assess and manage the risks associated with its prime brokerage business. The bank relied heavily on Archegos' self-reported financial information and did not conduct sufficient due diligence on the client's investment strategy and risk profile. This lack of proper risk assessment led to an over-reliance on Archegos' self-reported data, which proved to be inaccurate.
- Corporate Governance: The case highlights weaknesses in Credit Suisse's corporate governance structure. There was a lack of clear accountability and oversight within the organization, particularly regarding risk management. The bank's risk management team was not adequately empowered to challenge senior management's decisions, leading to a culture of complacency.
- Internal Controls: Credit Suisse's internal controls were inadequate to prevent the Archegos collapse. The bank lacked a robust system for monitoring client activity, identifying potential risks, and mitigating potential losses. The bank's risk management framework was also not sufficiently integrated with its other business lines, leading to a siloed approach that hindered effective risk identification and mitigation.
4. Recommendations
To mitigate future risks and prevent similar collapses, Credit Suisse should implement the following recommendations:
1. Enhance Prime Brokerage Operations:
- Strengthen Client Due Diligence: Conduct rigorous due diligence on all prime brokerage clients, including a thorough assessment of their investment strategy, risk profile, and financial resources. This should include independent verification of client financial information and a comprehensive analysis of their trading activity.
- Implement Robust Margin Call Procedures: Establish clear and transparent margin call procedures, including automatic triggers based on pre-defined risk thresholds. This should involve a multi-layered approach, with independent verification of margin calls and a robust system for managing margin calls in a timely and efficient manner.
- Develop a Comprehensive Risk Management Framework: Implement a comprehensive risk management framework tailored to the specific risks associated with prime brokerage, including a robust system for identifying, assessing, mitigating, and monitoring risks. This framework should be regularly reviewed and updated to reflect evolving market conditions and client profiles.
2. Improve Internal Controls:
- Strengthen Risk Oversight: Establish a strong and independent risk oversight function with clear authority to challenge senior management decisions and hold them accountable for risk management practices. This function should be adequately resourced and empowered to effectively monitor and manage risks across all business lines.
- Enhance Transparency and Accountability: Implement a culture of transparency and accountability throughout the organization, promoting open communication and encouraging employees to report any potential risks or concerns. This should involve clear reporting lines, regular performance reviews, and robust whistleblower protection mechanisms.
- Develop a Strong Compliance Culture: Foster a strong culture of compliance by providing comprehensive training to all employees on relevant laws, regulations, and internal policies. This should include regular assessments of compliance practices and a clear process for reporting and investigating any potential violations.
3. Enhance Corporate Governance:
- Strengthen Board Oversight: Ensure that the board of directors has a deep understanding of the risks associated with prime brokerage and is actively involved in overseeing the bank's risk management practices. This should include regular board-level discussions on risk management, independent assessments of risk management practices, and clear reporting lines to the board.
- Improve Risk Management Reporting: Enhance risk management reporting to the board and senior management, providing clear and concise information on key risks, risk mitigation strategies, and the effectiveness of risk management practices. This should include regular updates on the bank's risk appetite, risk tolerance, and risk management framework.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: These recommendations are aligned with Credit Suisse's core competencies in financial services and its mission to provide innovative and responsible financial solutions to its clients. By strengthening risk management and internal controls, Credit Suisse can enhance its reputation and maintain its position as a leading global financial institution.
- External Customers and Internal Clients: These recommendations aim to protect the interests of both external customers and internal clients, including investors, employees, and shareholders. By mitigating risks and enhancing transparency, Credit Suisse can build trust and confidence in its operations.
- Competitors: These recommendations are consistent with best practices in the industry, ensuring that Credit Suisse remains competitive in the global financial market. By implementing robust risk management and internal controls, Credit Suisse can differentiate itself from competitors and attract clients seeking a reliable and responsible financial partner.
- Attractiveness ' Quantitative Measures: These recommendations are expected to enhance Credit Suisse's financial performance by reducing the likelihood of future losses and improving its risk profile. This will likely lead to improved profitability, increased shareholder value, and greater investor confidence.
- Assumptions: These recommendations are based on the assumption that Credit Suisse is committed to improving its risk management and internal control framework. The success of these recommendations also depends on the willingness of senior management and the board of directors to implement these changes and hold employees accountable for their actions.
6. Conclusion
The Archegos collapse highlights the critical importance of effective risk management and internal controls in the financial services industry. By implementing these recommendations, Credit Suisse can mitigate future risks, restore investor confidence, and strengthen its position as a responsible and reliable financial institution.
7. Discussion
Other alternatives not selected include:
- Exiting the prime brokerage business: This would eliminate the risks associated with this business line but would also reduce Credit Suisse's revenue and market share.
- Continuing with minimal changes: This would maintain the status quo, but it would expose Credit Suisse to continued risks and potential future losses.
The key risks associated with these recommendations include:
- Resistance to change: Senior management and employees may resist the implementation of these changes, leading to delays and potential implementation challenges.
- Cost of implementation: Implementing these recommendations will require significant investment in resources, training, and technology.
- Unforeseen risks: Despite these recommendations, Credit Suisse may still face unforeseen risks that could lead to future losses.
8. Next Steps
To implement these recommendations effectively, Credit Suisse should follow a phased approach:
- Phase 1 (Short-Term): Implement immediate improvements to client due diligence, margin call procedures, and risk oversight. This should include a comprehensive review of existing policies and procedures, as well as the development of new policies and procedures to address identified weaknesses.
- Phase 2 (Medium-Term): Develop and implement a comprehensive risk management framework, including a robust system for identifying, assessing, mitigating, and monitoring risks. This should involve a multi-layered approach, with independent verification of risk assessments and a clear process for reporting and escalating risks.
- Phase 3 (Long-Term): Foster a strong culture of compliance and accountability throughout the organization, promoting open communication and encouraging employees to report any potential risks or concerns. This should involve comprehensive training on relevant laws, regulations, and internal policies, as well as regular assessments of compliance practices.
By implementing these recommendations and following a phased approach, Credit Suisse can strengthen its risk management and internal control framework, mitigate future risks, and restore investor confidence.
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Case Description
In 2021, the investment bank Credit Suisse Group AG lost an estimated US$6.4 billion from exposure to two hedge fund implosions that occurred within a month. Archegos Capital Management lost US$4.7 billion and Greensill Capital lost US$1.7 billion. Various arrangements between Credit Suisse Group AG and Archegos Capital Management, as well as structural factors at Credit Suisse Group AG, may have contributed to the bank having a higher level of exposure to these collapses than its industry peers. Underlying these miscues were recent changes in leadership, strategy, and tone at Credit Suisse Group AG. All three of these changes appeared to have collectively impaired the skepticism and voice exercised by its risk management group. In July 2021, Credit Suisse Group AG replaced its chief risk officer in an attempt to reshuffle its risk and compliance leadership. The task of the new chief risk officer was to reshape Credit Suisse Group AG's risk management framework and internal controls, from the top to the bottom.
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