A hedge fund run by a former JPMorgan Chase & Co. executive who helped create the credit-derivatives market is aiding the lender as it unwinds trades in an index at the heart of a loss of more than $2 billion.
BlueMountain Capital Management LLC, co-founded by Andrew Feldstein, has been compiling trades in recent weeks that would offset JPMorgan’s risk in Series 9 of the Markit CDX North America Investment Grade Index, then selling the positions to the bank, according to three people outside the firms who are familiar with the strategy. That allowed the bank, which is said to have amassed as much as $100 billion in bets on the index, to unwind trades outside the traditional web of dealers.
“They used BlueMountain to disguise what they were doing,” Peter Tchir, founder of New York-based macro advisory firm TF Market Advisors, said in a telephone interview. “It all gets a little bizarre and shows how screwy this whole market is.”
JPMorgan tapped BlueMountain as a middleman after trades in its London chief investment office grew so large that the bank was creating price distortions that hedge funds sought to exploit, said the market participants, who asked not to be identified because they weren’t authorized to discuss the trades. BlueMountain was one of the funds that benefited from the price dislocations, the people said.
Doug Hesney, a spokesman for New York-based BlueMountain, declined to comment, as did JPMorgan’s Kristin Lemkau.
Trading volumes in the past three weeks signal JPMorgan has been unwinding its positions in the Markit CDX index known as IG9, a credit-default swaps benchmark created in 2007 that’s linked to the debt of 121 companies in the U.S. and Canada.
A record $31 billion of IG9 index contracts expiring in December 2017 traded June 19, up from a daily average of $2.4 billion in the previous three months, according to Markit Group Ltd., which administers the index.
The trading surge in the contracts that fueled much of JPMorgan’s loss follows a 35 percent reduction in the net amount of protection that dealers sold on the index in the three weeks ended June 15, data from the Depository Trust & Clearing Corp. show.
JPMorgan is seeking to stem the losses after its chief investment office shifted its strategy of buying credit-default swaps on corporate debt to protect the bank against a financial crisis or deteriorating economy. At the start of the year, the group was ordered to reduce its positions and instead executed a series of trades that left the bank with even bigger and harder-to-manage exposures, Chief Executive Officer Jamie Dimon told the Senate Banking Committee in Washington last week.
Bloomberg News first reported April 5 that Bruno Iksil, a trader in the chief investment office’s U.K. group known as the London Whale, had built a portfolio of credit derivatives so large it distorted price relationships in the market. Total net wagers on the IG9 index surged an unprecedented 67 percent to $150 billion in the 17 weeks ended April 27 as Iksil was said to have amassed his position, DTCC data show.
While Iksil is still employed by the bank, Henry Kim is now trading synthetic credit in the CIO, reporting to Rob O’Rahilly, who replaced Achilles Macris as the chief investment officer of Europe, Middle East and Africa, a person familiar with the moves said.
Feldstein helped create the credit-default swaps market while he worked for JPMorgan in the 1990s before co-founding BlueMountain in 2003.
Dimon, 56, defended the company’s disclosures of the trading loss on June 19, testifying before a House Financial Services Committee hearing in Washington.
“We disclosed what we knew when we knew it,” Dimon said.
Dimon also said he was “dead wrong” when he dismissed news reports about the trades as a “tempest in a teapot” during an earnings call with analysts on April 13.
He declined to disclose the size of the loss, saying the bank will provide that information along with more details of the position when JPMorgan reports earnings on July 13. Unwinding the positions by the end of this month allows the bank to take losses in the current quarter.
JPMorgan’s share price has declined more than 10 percent since Dimon revealed the loss on May 10.
After the disclosure, the cost of CDX IG9 swaps surged as hedge funds and other traders placed opposite bets that the bank would be forced to unwind its position.
The index climbed as much as 49 basis points to 175 basis points on June 5, according to prices from data provider CMA. The contracts have since fallen back to 152, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
Unwinding the trade may have been eased by both a decline in the index and an increase in trading across the market as participants began moving positions into the current benchmark expiration date. Dealers begin offering new standard contract maturities for swaps on individual companies every three months, and that can boost trading in indexes from hedge funds and others that profit from gaps in the indexes and swaps on their individual components, said Otis Casey, director of credit research for Markit in New York.
“If you were to need to move a large position, there should be greater liquidity around those days than other days, all else being equal,” Casey said in a telephone interview.