Monday, April 9, 2012

JP Morgan's CDS trade pushing regulators to realize need for ultra transparency

According to a Bloomberg article, JP Morgan's CDS trade is having one beneficial impact.  It is pushing regulators to realize why they need the help of market participants and ultra transparency to understand the risks of a global financial institution.

This trade has confirmed several of the reasons that banks should be required to provide ultra transparency and disclose on an ongoing basis their current asset, liability and off-balance sheet exposure details.
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....
First, the trade confirms the need for ultra transparency as the only way to distinguish between risk management and speculation is by looking at the exposure details.
[A] London-based trader ... 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.
Second, the trade confirms the need for making ultra transparency available to all market participants as the regulators were not on top of this trade.

Keep in mind, this trade is so sizable that it is supposedly moving markets at an estimated size of approximately $100 billion.  Where were the regulators when the trade was at say $20 billion? $40 billion?
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. 
While there are a number of legitimate reasons for opposing the Volcker Rule, this trade does suggest that regulators do not have their arms around what is happening in JP Morgan's trading operation.
Details on [the] 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.”...
A call for ultra transparency.
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...
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.”...
Third, this trade shows how in the absence of ultra transparency we are gambling with financial stability as financial market participants are dependent on the regulators to properly assess and communicate the risk of each bank.

Is a trade that distorts markets but is not reported to the public as quickly as possible consistent with regulators properly assessing a bank's activity?
The positions, by the bank’s calculations, amount to tens of billions of dollars and were built with the knowledge of [the trader’s] superiors, a person familiar with the firm’s view said.

[The trader] 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 [the] 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...  
“The only perfect hedge is in a Japanese garden,” he said.
Even if the trade is a legitimate hedge, the fact that the hedge has to be so large that it distorts the CDS market is a sure sign that JP Morgan is too big.

If JP Morgan was smaller, it wouldn't need to have put on such a large hedge.

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