Jpmorgan & the London Whale

JPMorgan & the London Whale

Group 6

1/ ORGANISATIONAL PROBLEMS:

• There is a conflict of interest regarding the CIO hierarchy. Indeed, the Chief Investment Officer, Ina Drew is both responsible for the investment and the risk management teams. Consequently, she is stretched between the high return objective and the risk control. With the two departments taking opposite position at a point in time, the conflict of interest was obvious and Drew could have order the investment division to make some move on certain assets in order to improve the P&L of the SCP. As said in page 11 of the case, the CIO had “become” the market on certain indices and thus, any move on those indices by the investment team would have the opposite effect on the SCP’s P&L.

⇒ The solution could be to create a risk management position independent of the investment team. This way, the conflict of interest would not exist anymore.

• Another concern arises regarding the reporting. Indeed, as the case states it, we understand that each division of JPMorgan can have its own risk management model. Even within the CIO department, the SCP runs a specific calculation of the VaR in order to hide losses.
• Moreover, the new VaR model is implemented without complying with the testing period of several months required by the Model Risk and Development office.

⇒ As a change, we would implement a single VaR calculation model and a unique frame for risk reporting for the whole bank. By harmonizing risk control and management, we would improve the quality of JPMorgan reporting as well as its transparency.

• RWA reduction : One of the CIO objectives was to reduce the RWA in order to not breach the limits, but there was no specific schedule of progress nor any explicit guidelines regarding the amount of trading losses management would be willing to withstand in order to meet the specified reduction in RWA.
  ⇒ The CIO should define the objective of RWA reduction quantitatively and on a given period.
• At JP Morgan, the CIO had a really large discretion regarding the portfolio management (choice of securities and concentration). Moreover, this position was less supervised in term of regulatory compliance by the top management.
  ⇒ As a really exposed job position, the CIO investment decisions should be more controlled by the hierarchy.

2/ MODELS PROBLEMS:

• The hedging of the portfolio was, since the beginning, not really appropriate. The SCP initial positions were expected to be CSBPV neutral to small market moves. But in practise, it was not the case because the long IG protection was losing more money than their short HY exposure.

⇒ The hedging structure should be modified in order to neutralize all the market risks.

• Mark to Market issue: Martin-Artajo asked Iksil to disregard the usual way of Marking-to-Market with the argument that he thought the market was wrong and didn’t reflect the true fair value of the derivatives in the portfolio. This was another way to duff the P&L of the SCP.

• The VaR: the use of VaR is here limited by the robustness of the data underlying each security. Indeed, VaR is more reliable when assessing the risk of liquid securities with extensive pricing history. With OTC instruments, the trading frequency may not be high enough.

• CSBPV and CSW10%: These are sensitive measures. Utilizing such measures for a portfolio balancing implies the assumption that the positions (constituting the portfolio) are also moving linear, at the same time and amplitude.

A lack of market liquidity and the enormous size of the SCP could be an explanation for the poor performance of VaR and the other measures.

Even if they tried to implement a modified VaR model, there is no really research on the risk measure and the relevancy of models previously quoted. Indeed, assuming that the model were applied properly, these ones were never questioned in order to know if they were able to detect the risk.

⇒ Thus, a way for improving the risk management would be to look into the different model appropriate for the detection and analysis of risk in this specific type of position. Moreover, the collaborators have to apply properly the model and the guidelines associated. Research and formation would be key in this improvement.