Market-moving trades by JPMorgan Chase & Co. (JPM)’s chief investment office probably will force regulators to seek more detail on banks’ derivatives positions to help them distinguish risk management from speculation.
Bruno Iksil, a London-based trader in the unit, has built derivatives positions linked to corporate credit that are so big he’s moved markets, according to hedge fund managers and dealers. While Joe Evangelisti, a bank spokesman, said yesterday that the trades are part of the firm’s hedging strategy, four market participants said they resemble proprietary bets, or wagers with the lender’s own money.
Executives at New York-based JPMorgan, the biggest U.S. bank with $2.27 trillion of assets at year-end, have opposed the so-called Volcker rule that seeks to prevent banks with federal backing from making speculative trades. Details on Iksil’s positions are too sparse for regulators to determine whether they should be permitted, said Frank Partnoy, a former derivatives trader who’s now a law and finance professor at the University of San Diego.
“This could be an almost completely matched, hedged position, or it could be massively risky, and there’s just no way to tell without getting more complete disclosure,” Partnoy, author of “Infectious Greed: How Deceit and Risk Corrupted the Financial Markets” said in a phone interview. “I’m surprised that regulators don’t see this example and cry out for more disclosure and more information about these contracts.”
Judith Burns, a Securities and Exchange Commission spokeswoman, declined to comment on whether the agency is looking into the trading. Bryan Hubbard, a spokesman with the Office of the Comptroller of the Currency, which regulates banking at JPMorgan, and the Federal Reserve’s Barbara Hagenbaugh also declined to comment.
The three regulators are among those working on the final version of the Volcker rule.
Regulators are stationed in JPMorgan’s offices and are aware of what the bank is doing, said a person familiar with the company’s thinking, who asked not to be identified because he wasn’t authorized to discuss it.
The results of JPMorgan’s chief investment office “are disclosed in our quarterly earnings reports and are fully transparent,” Evangelisti said in a phone interview.
Harvey Pitt, a former U.S. Securities and Exchange Commission chairman, said yesterday in an interview on Bloomberg Television’s “InBusiness With Margaret Brennan” that trading such as Iksil’s should raise regulatory concerns because it’s influencing market prices.
“I’d want to talk with the folks at JPMorgan and understand exactly what took place here,” Pitt said. “And then I would try to get a report out to the public as quickly as possible to dispel concerns about things that may not have occurred and to raise issues about things that actually did occur.”
Arthur Levitt, another former SEC chairman who is a senior adviser to Goldman Sachs Group Inc. (GS), said in a radio interview on “Bloomberg Surveillance” that he expects regulators will require more information on banks’ derivatives positions.
“And I think that is unfortunate,” said Levitt, who also is on the board of Bloomberg LP, the parent of Bloomberg News. “That raises all kinds of competitive issues.”
JPMorgan holds a portfolio of investment-grade debt and uses “credit-related instruments” such as derivatives to protect against a decline in the value of the holdings, Evangelisti said.
‘Simply a Balancing’
“Our most recent activity noted in the media is simply a balancing of those credit-related investments to reduce the impact of our hedge,” he said. “We do this in the ordinary course of our asset- and liability-management activities.”
Jack Gutt, a spokesman at the Federal Reserve Bank of New York, declined to comment on whether the New York Fed is examining the trades. Jamie Dimon, JPMorgan’s chairman and chief executive officer, is on the New York Fed’s board of directors.
“This will be the first test of how aggressively the Fed will enforce the Dodd-Frank Act,” which includes the Volcker rule, said Mark Williams, a lecturer at Boston University’s School of Management. “From a Fed regulatory standpoint, I see JPMorgan as having some serious explaining to do.”
The positions, by the bank’s calculations, amount to tens of billions of dollars and were built with the knowledge of Iksil’s superiors, a person familiar with the firm’s view said.
Iksil may have built a position totaling as much as $100 billion in contracts in one index, according to the market participants, who said they based their estimates on the trades and price movements they witnessed as well as their understanding of the size and structure of the markets.
Even if regulators are satisfied that Iksil’s trades are intended to hedge other risks the bank is taking, regulators should be aware that derivatives often fail as offsets because of differences in the way contracts are written and traded, Partnoy said.
“It’s not a pure hedge, it has a speculative element to it, and that’s particularly true when the contracts are this big, when you’re talking about tens of billions of dollars,” said Partnoy, whose new book “Wait: The Art and Science of Delay” is being published in June by PublicAffairs.
“The only perfect hedge is in a Japanese garden,” he said.