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Risk Management

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JPMorgan Investment Unit Played by Different High-Risk Rules

The JPMorgan Chase unit that lost more than $2 billion through a failed hedging strategy had looser risk controls than the rest of the bank.

LONDON/FRANKFURT - The JPMorgan Chase & Co. unit that lost more than $2 billion through a failed hedging strategy had looser risk controls than the rest of the bank, according to people familiar with the situation.

The risk of losses is tallied by the bank using a so-called value at risk (VaR) calculation. However, the Chief Investment Office, the unit responsible for the high-profile loss that JPMorgan disclosed last Thursday, had a separate VaR system.

It used a less stringent calculation that gave a lower risk assessment of its trades, according to people who previously worked at the bank.

The unit also reported directly to CEO Jamie Dimon, a factor which allowed it to maintain a separate risk monitoring set-up to other parts of the investment bank, these people said.

Despite repeated warnings from executives inside the firm as long ago as 2005, the CIO unit remained notably free from oversight.

A source with knowledge of the situation said that these warnings included the size of the CIO, the fact that its risk reporting was not transparent and the scope for the unit to get "bigger and bigger" because it had a lower cost of funding than the rest of the investment bank.

Until April, the CIO unit's unusual autonomy allowed it to build up risky positions without triggering alarms.

Indeed, the unit was encouraged to be a profit center, as well as hedging against risk, a source with direct knowledge of the unit said. Ina Drew, who headed the unit, earned more than $15 million in each of the past two years, making her among the highest-paid executives at the bank and one of the most compensated women on Wall Street.

Drew could not be reached for comment, and declined to speak with a reporter who visited her house.

"It created incentives to take extraordinary risk in one pocket of the bank" that was different from the rest, the source said. "If someone's getting paid $15 million, it's a profit center."

JPMorgan declined to comment on the CIO unit or its trades.


While the bank didn't completely ignore risks at the unit, any assessment can overlook problems if it is measuring risk with the wrong yardstick.

When reports surfaced last month that one of JPMorgan's CIO unit traders in London had taken a huge position in credit derivative markets, JPMorgan officials were prompted into taking a closer look at the risk in the CIO unit, banking sources, including a former CIO employee, told Reuters.

About two weeks ago, the bank finally applied its more stringent risk model to the CIO's trades. It got a nasty surprise: the model revealed that the maximum amount the CIO could lose in a single day had soared, one of the sources said.

Recent regulatory filings illustrate the rise in risk. A filing from April 13 showed a daily VaR for the CIO unit of $67 million. But a May 10 filing, showed it had risen to $129 million. That means the amount the unit could lose on most days had nearly doubled, and on some days it could lose much more.

By the time the increase was discovered, its positions had grown to a size that made it impossible for the bank to quickly unwind the trades, the sources said.

The trader in question, Bruno Iksil, was dubbed the "London Whale" because JPMorgan's positions were so large that other market players could detect them easily. That made the bank a sitting target for hedge funds who wanted to trade against the positions. Iksil could not be reached for comment.

The CIO unit also had a lower cost of capital than other parts of the bank, an artificial advantage that gave it an incentive to take more risk and behave in a less disciplined way, people familiar with the unit said.

"It was very large, but was never very transparent, and it wasn't clear that they had an appropriate funding cost," said the source with direct knowledge of the CIO. "They were running more risk than the investment bank - and with no peer review process (from those in the investment bank)."

Another warning came in March 2011, when a labor union-backed group said the board lacked expertise on its risk policy committee, the board level body responsible for overseeing risk.

The analysis, by CtW Investment Group on behalf of union pension funds, said JPMorgan's board had "serious deficiencies" compared with the boards of other banks.

Ironically, JPMorgan invented value-at-risk as a tool for measuring exposure to trading losses.

The tool emerged in the wake of the 1987 stock market crash when Sir Dennis Weatherstone, JPMorgan's British-born chairman, asked his division chiefs to put together a briefing to answer the question: "How much can we lose on our trading portfolio by tomorrow's close?" (Additional reporting by Matthew Davies at IFR; Editing by Alexander Smith, Alwyn Scott and Matthew Howell)

Copyright 2010 by Reuters. All rights reserved.

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