Regular readers know that if JP Morgan were required to provide ultra transparency and disclose its current asset, liability and off-balance sheet exposure details, then market participants could independently assess and model its risk.
JPMorgan Chase & Co. (JPM)’s multibillion- dollar trading loss exposed an industry practice that U.S. regulators are now likely to clamp down on: Banks keep investors in the dark about how they calculate trading risks.
The U.S. Securities and Exchange Commission is probing JPMorgan’s belated May 10 disclosure that a change to its mathematical model for gauging trading risk helped fuel the loss in its chief investment office.
While the SEC would have to prove that the biggest U.S. bank improperly kept important information from investors, regulators probably will press Wall Street firms to tell more about the risks they’re taking, three former SEC lawyers said....JP Morgan did keep important information from the investors. The important information was the actual trades. Without the exposure details, investors could not possibly assess the risk of JP Morgan.
JP Morgan's trading models are just like the management commentary at the beginning of an annual report. Designed to show that everything is wonderful.
The only important information is the actual trades. With this information, market participants can use their own models to assess the risk.
“It was exceedingly difficult for third-party analysts to diagnose the magnitude of JPMorgan’s CIO hedging portfolio risk buildup based on bank-provided disclosures,” David Hendler, an analyst at CreditSights Inc., wrote in a June 18 report. Only “on-the-ground” hedge funds trading credit derivatives could discern the buildup, he wrote.Confirmation that it is only the actual trades that are important information.
Banks typically disclose only changes to the broadest parameters of their risk models. In 2008, for example, JPMorgan switched its VaR formula to use the 95 percent “confidence level” from 99 percent, according to the bank’s annual report for that year. The move, which reduced the bank’s year-end VaR to $286 million from $317 million, was intended to “provide a more stable measure,” the bank said.And confirms that trading models are just another form of opacity. A bank would rather disclose the result of its trading models than the positions it is actually taking.
If the position loses a lot of money like JP Morgan's did, oops, the model was wrong. The bank promises to fix the model and continues taking proprietary bets.
With actual trades disclosed, the opacity of the models goes away and everyone can see what the bank is actually doing.