LESSONS FROM $6 BILLION JP MORGAN LOSS

US authorities have charged two JP Morgan Chase traders with fraud in the $6 billion loss suffered by JP Morgan in what is known as the "London whale" case.
The US Department of Justice, SEC, UK’s Serious Fraud Office have charged two London based traders Mr. Martin-Artajo, who was responsible for JP Morgan's trading strategy in London, and Mr. Grout, who submitted the trades for artificially increasing the market value of securities to hide the true extent of losses. Others also may get charged as the case progresses but there are few lessons for the risk managers.

1. It is a fact that the risk in the securities markets cannot be determined with complete accuracy. Depending on complex models can lead to excessive exposure. It is important for risk managers to qualitatively assess the quality & the quantity of risks against the risk appetite.

2. Risks of hedging using derivatives have to be understood properly. It is possible for the investment managers to overlook the inherent risks and instead focus on derivatives as the panacea for risks. Risk managers have to provide the “voice of reason” on the over-dependence on hedging as risk management strategy.

3. Excessive volatility of the securities markets may provide a trigger to take greater risks. When the mark to market investments sees a decline in value, the responsible person’s compensation and advancement may get impaired. They have every incentive to try to recoup the losses. Risk managers & auditors can get more involved in the investment strategy and trading processes to identify any discrepancies in a more timely.

4. Finally no system of internal controls can eliminate the risk of the human circumvention and the increased monitoring can only identify breach of controls so that corrective measures can be taken. The tone of risk management has to flow from the top and the structures, processes, compensation, systems and monitoring have to be in-line with the risk management objectives.

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