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From Credit Default Swaps to Synthetic Credit Portfolio or from legitimate hedges to speculative bets

In the wake of the 2B usd loss at JPMorgan Chase, let’s focus on some of the issues from a US standpoint because in certain respects it does affect both International and European banks. In the EU we naturally have just as many changes in the European legislation on financial and capital markets compared with the US Dodd Frank Act. The jury is currently still out on whether Dodd Frank is remarkably poorly thought, but its implications will be monumental and will sadly also leak into Europe and the rest of the world.

Kersi Porbunderwalla
Kersi Porbunderwalla
Some of the questions that many financial professionals are currently posing in the wake of the recent 2B usd loss at JPMorgan Chase are.
- Do financial institutions need even more new rules, mandates and oversight to avoid a repetition of the 2008 crisis? Whatever happened to the idea of breaking up of the top International and US banks, because due to their size and complexities, these banks cannot have adequate risk management?
- Have the banks stopped using the more than 20 year old value-at-risk model that can catch risky positions before they produce losses?
- Where was the Dodd-Frank rule from 2011 that would curtail risky and speculative trading with the banks’ own capital?

The short answer to these questions could be that because we have de facto privatised profits and socialised losses in the financial sector the questions no longer seem to be valid.

High speed computerized trading
The financial guru’s, at least in the US after receiving massive handouts, want the trade transactions in the financial sector, to be ever faster is not always an economic gain, either for investors or for the economy. High speed trading and computerized trading don't add much to the economy, and they can do massive damage when things go awry. With this type of trading, they will always be below the financial oversight authorities’ radar. Unless the oversight authorities get their act together, and find ways and means of controlling these high speed trading and computerized trading platforms, we will continue to see massive losses, from time to time.

Some of the recent comments to the new legislation providing the oversight authorities with controlling powers are:

- Jamie Dimon, the chief executive of JPMorgan Chase, has been rather vocal to denounce the financial reform plans altogether. • The leading banks hate the current stipulations of the Volcker Rule, because less gambling means lower profits and lower bonuses for executives and traders.
- The possible future US president Mitt Romney hates financial compliance and has called for repealing Dodd-Frank Act altogether.
- Others say that President Obama has not done enough to ensure that the financial services industry is compliant at all times.

Poorly monitored and flawed trades
What shall we then do to the international financial services industry? Is it like a pit-bull on steroids that continue to behave in an erratic manner? Probably it is due to the sheer structure of the global finances and transactional processes that make it impossible to control and comply by the oversight authorities.

Or is it as Mr. Jamie Dimon, the chief executive of JPMorgan Chase said when he informed of the 2B usd loss that it was due to sloppiness, poor judgment and stupidity — that had led to the loss. Many other observers feel that it was due to a massive failure in risk management and internal controls that should have provided early warning signs when the trades at JPMorgan Chase were flawed and poorly monitored.

In the aftermath of the financial crisis, the too big to fail banks said they had learned their lessons, had full control on the risk on their balance sheets, due to the Dodd Frank Act pulled back from making large bets with their own money and stopped proprietary trading at government-backed banks.

Therefore, the JPMorgan Chase trading bet loss is a severe reminder that the banking system continues to be vulnerable to market shocks and that significant banks continue to make risky financial bets that could threaten the economy because they are not compliant.

Should we not be debating the problem that banks are too big to fail may be because of its size, has created a new risk: The Financial Institutions are too big to manage. The JPMorgan Chase loss of $2 Billion could easily get worse.

At the Copenhagen Compliance Conference on the 6th and 7th June, there will be ample time to discuss the above questions and the current financial compliance issues with a series of international experts.

By Kersi Porbunderwalla
Kersi Porbunderwalla is the founder and CEO of Riskability®, Copenhagen Compliance® and Copenhagen Charter®. After his early retirement from ExxonMobil, Kersi has been involved in several Global Good Governance, Risk Management and Compliance (GRC) Projects for multinationals like IBM, Shell, BP, Volvo and others. He continues to implement GRC journeys for a variety of clients to develop custom tailored GRC folder that includes methodologies, roadmaps, and specific solutions to assignments, training and certification. Kersi conducts workshops, seminars and conferences that focus on developing and implementing GRC applications & frameworks into operational environments. He is a consultant, instructor, researcher, commentator and practitioner on 4 continents.


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Mardi 5 Juin 2012

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