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JPMorgan's Losses Become Tool in Dodd-Frank Rules Debate

CFTC to Release Clearing Proposal for Index Swaps, Gensler
Futures Trading Commission Chairman Gary Gensler. Photographer: Chip Somodevilla/Getty Images

U.S. lawmakers and regulators are seizing on the more than $2 billion in losses disclosed by JPMorgan Chase & Co. to bolster their positions in the nearly two-year-old debate over Wall Street’s rules.

The Senate Banking Committee was the flash point for the debate yesterday, as Democrats and the chairman of the Commodity Futures Trading Commission used the losses to argue for the strict implementation of the 2010 Dodd-Frank Act rules, including a ban on proprietary trading by banks. That argument may shift to lawmakers and regulators pushing to go beyond President Barack Obama’s financial regulatory overhaul.

“In the short run, pressure is on regulators to at least look tough in implementing the Volcker Rule,” Brian Gardner, senior vice president at investment bank Keefe Bruyette & Woods Inc., said. “Over longer run, I believe the bigger impact will be on the move to break up or downsize the largest banks.”

JPMorgan’s May 10 disclosure of losses tied to structured derivatives products came at a key point in the debate over the future of the Dodd-Frank Act. Agencies including the CFTC and Securities and Exchange Commission are still in the process of writing and implementing some of the most controversial rules required by the law.

Senate Banking Committee Chairman Tim Johnson said the losses bolster the case for the regulations included in the Dodd-Frank Act and serves as a “wake up call for many opponents” of the law’s provisions.

‘Stark Reminder’

“The company’s massive trading loss is a stark reminder of the financial crisis of 2008 and the necessity of Wall Street reform,” said Johnson, who also said he had been briefed by regulators and the bank about the losses.

The types of derivative swaps said to have led to a loss of at least $2 billion at JPMorgan Chase & Co. may be the first for which CFTC would require guarantees by clearinghouses under the Dodd-Frank Act, CFTC Chairman Gary Gensler said in his written testimony.

The commission, the main U.S. derivatives regulator, would seek comments this summer on the requirement for swaps of interest rates and credit-default indexes, according to Gensler.

“Standard swaps between financial firms will move into central clearing, which will significantly lower the risks of the highly interconnected financial system,” Gensler said.

Calling on Dimon

JPMorgan Chairman and Chief Executive Officer Jamie Dimon, a vocal critic of some of the provisions included in Dodd-Frank, will make an appearance in front of the committee in the months ahead and Johnson, the panel’s chairman, said that he expects the executive to explain the details of “a very complex trade.” That trade has drawn the scrutiny of federal regulators and the Department of Justice.

Republicans, most of whom opposed the Dodd-Frank Act on the Senate floor, questioned the law’s effectiveness -- and asked regulators not to bow to pressure to tighten some rules in the wake of the high profile JPMorgan losses.

“What you’re going to do is end up causing the Volcker rule to end up being something it was never supposed to be,” Senator Bob Corker, a Tennessee Republican, said.

Securities and Exchange Commission chairman Mary Schapiro said her agency is currently focused on what JPMorgan knew and when the bank learned about the details of the losing trades.

“Our focus right now is on whether the company’s financial disclosure and reporting is accurate,” Schapiro said.

CFTC Acting

Gensler, who in his remarks again confirmed the agency’s enforcement division had opened an investigation into the losses, said there is a “great deal of consistency” between the CFTC’s timeline on clearing rules and the time frame of regulators in Europe and Japan.

Gensler also said that the CFTC has “clear anti-fraud and anti-manipulation power” over credit derivatives indexes.

JPMorgan trader Bruno Iksil may have amassed a $100 billion position in contracts on Series 9 of the Markit CDX North American Investment Grade Index, counterparts at hedge funds and rival banks said in April.

JPMorgan said on May 10 that it has lost at least $2 billion on derivatives trades. In his testimony Gensler said the Markit CDX and iTraxx credit default swap indexes would be among the first to fall under the proposed guarantee requirements. Lawmakers are probing the role of regulators in the losses -- including when they knew of the losses and what changes, if any, to regulations would prevent similar losses from Wall Street firms in the future.

Overseas Reverberations

“We’ve had another stark reminder of how trades overseas can quickly reverberate with losses coming back into the United States,” Gensler said.

Those losses have thrown uncertainty into the future of a derivatives measure in the House aimed at restraining the reach of U.S. regulators into foreign swaps markets that was scheduled to be considered last week.

Senator Jeff Merkley an Oregon Democrat who led much of yesterday’s hearing, continued his push to use the JPMorgan losses to support the case for tighter restrictions in the so-called Volcker rule that is currently moving through the rule-writing process. Five regulators, including the SEC and CFTC, are in the midst of crafting the final rule that would ban proprietary trading by banks.

Merkley and Senator Carl Levin, a Michigan Democrat who co-wrote the provision in Dodd-Frank, said the trading losses underline why hedging on a portfolio basis should be barred in the final rule. Gensler and Schapiro both acknowledged the difficulty regulators face in allowing some risk mitigating hedging.

“I think this is one of the more challenging tasks that regulators have been given,” said Gensler. Congress was “pretty clear” that hedges had to be tied specifically to individual and aggregate positions, he added.

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