PMorgan Blunder Puts Bank In Regulators' Crosshairs
Katy Burne and Max Colchester
Of DOW JONES NEWSWIRES
LONDON -(Dow Jones)- A complex web of credit-derivatives trades that blew up in the face of J.P. Morgan Chase & Co. (JPM) in recent weeks, causing it to admit to more than $2 billion in trading losses Thursday, has brought the bank and potentially its peers unwanted attention from regulators just as confidence in the financial sector had been improving.
It is unclear how deeply exposed J.P. Morgan is to the troublesome trading positions, and therefore what its future losses or gains could be beyond the loss already realized. At the moment, however, the bank's missteps represent a gravy trade for hedge funds and others betting against J.P. Morgan and will attract increased regulator attention worldwide.
Already, the J.P. Morgan officials have begun discussions with U.K. regulators about the trading losses incurred by the giant bank's investment office in London, people familiar with the matter said. The talks with the Financial Services Authority don't represent a formal inquiry, one person said, and it isn't clear if it will result in any regulatory action. The FSA has been requesting information from J.P. Morgan about how the trading losses occurred and what steps the bank is taking to avoid such situations in the future, the people said.
Jamie Dimon, chief executive of the U.S. banking giant, said the trades aren't bets with the firm's own capital, or so-called "proprietary" trading that would be reined in under the proposed Volcker Rule in the U.S. The bank has characterized the trades as legitimate hedges of risks elsewhere in the banking group that went awry.
Nevertheless, the losses and procedural flaws that have come to light in the wake of the activity demonstrate the need for regulators to closely define proprietary trading and how much risk should be involved even in hedging.
"Dimon has been at the forefront of trying to get regulatory moves softened," said Gary Jenkins, founder of Swordfish Research in London. "I don't see regulators or rating agencies giving the banks any benefit of the doubt now."
The problem trades stemmed from J.P. Morgan'sLondon-based Chief Investment Office, and credit traders have pointed to the culprit being a France-born trader at the bank, Bruno Iksil, who in earlier reports by the Wall Street Journal has been described as being nicknamed the "London Whale."
Politicians will have to decide if units like J.P. Morgan's CIO group are necessary to help them steer through periods of volatility or more likely to be their undoing. The scores of hedge funds betting against the bank are speculating that the CIO group may be pressured to unwind some of its large trades, helping them make profits as the positions sour on J.P. Morgan and work in their favor.
"The question lawmakers have is whether these 'Moby Dick' trades in London could bring down the 'Pequod,' or here, the mother ship in the United States," said Matthew Kerfoot of law firm Dechert LLP. "Regulators are worried about the possibility of a huge default by a foreign subsidiary resulting in the bankruptcy and bailout of its U.S. parent."
In an interview in recent weeks about proposed legislation in the U.S. that would weaken the post-crisis regulatory overhaul, Rep. Barney Frank (D. Mass), senior Democrat former chairman of the House Financial Services Committee, said he is concerned about any new laws that would interfere with U.S. regulators' ability to police trades conducted abroad by U.S. firms.
"AIG did business through its foreign affiliates and we don't want it to be that we can never step in," said Frank, speaking before reports about the J.P. Morgan trades surfaced. "One of the things we learned [from the crisis] is the world is interconnected and problems in one place can hurt another."
In Europe, the Volcker rule hasn't been warmly received either. Earlier this year, Michel Barnier, the European commissioner for the internal market, complained about the impact of the Volcker rule, in part because it could hamper U.S. banks' ability to buy and sell European sovereign bonds on behalf of customers, reducing liquidity in those markets.
It also raises questions in the U.K., where the government is working on plans to force banks to segregate their retail activities from riskier investment-banking businesses in order to better protect depositors. While the debacle at JP Morgan reinforces the need to regulate the industry, it also underscores how hard it will be to ring fence these businesses, said Vivek Raja at Oriel Securities.
"It's not clear whether this activity would be inside the ring fence or not. The CIO was hedging with surplus deposits and this could in theory fund the retail and commercial bank," Raja said.
So far, the market isn't calling for Dimon's head as a result of the London trades, but there have been questions about the chain of events leading up to the recent losses, and the extent to which Dimon was briefed on the trades.
Iksil was following instructions from CIO executives and is not a rogue trader, people familiar with the matter say. The web of trades was so complicated, they add, that it is possible the orders were not correctly followed within the CIO group, leading to less tidy hedging.
It also raises questions about whether the CIO activities are isolated or common among other banks, contributing to negative headline risk.
Analysts at FBR Capital Markets & Co. said lowered their rating on the bank to "market perform" from "outperform" Thursday. "The trading loss announcement will certainly be fodder for the Washington, D.C. crowd pushing for the Volcker Rule and will certainly increase the headline risk for JP Morgan and the industry," they wrote in a commentary.
-By Max Colchester and Katy Burne, Dow Jones Newswires;
