JPMORGAN CHASE WHALE TRADES: A CASE HISTORY OF DERIVATIVES RISKS AND ABUSES

management. 1195
215
While each of these steps is important, the bank did not mention taking any
steps to reduce the number of and variations in its risk models or to prohibit bank personnel from
gaming its risk metrics and models to produce artificially lower risk profiles, RWAs, and capital
requirements.
E. Analysis
Despite JPMorgan Chase’s reputation for strong risk management, little attention was
paid by bank personnel – including Mr. Dimon – to the many breaches and risk warning signals
that should have led to an early review of the CIO’s risky trades. This lack of attention was due,
in part, to the fact that Ina Drew exercised nearly unfettered discretion as a manager. She also
granted broad discretion to her risk management personnel and traders. When risk limits are
breached, bank management should react, not by dismissing the breach or questioning the risk
metrics, but by requiring independent risk experts to investigate the risky activity, even when
trusted managers are involved. Risk managers should verify the causes of the risk limit breaches.
This trust-but-verify approach is essential to ensure breaches are investigated and corrective
action taken. Regulatory oversight into the frequency and nature of risk breaches and how they
are resolved, as examined in the next chapter, is also critical.
Another problem involves modern reliance by both banks and regulators on mathematical
metrics and models to measure risk, especially with respect to synthetic derivatives, which are
inherently hard to value, have no underlying assets to stem losses, offer unreliable past
performance data, and often undergo split-second trading and price changes. Risk metrics and
models with complex variations can proliferate at a financial institution with the size and variety
of JPMorgan Chase, and the pressure on analysts to reconfigure those metrics and models to
produce lower risk results is difficult to counteract. OCC regulations already contain numerous
safeguards against manipulation, requiring risk models to be developed by independent experts,
tested to see if they detect specific risk problems, and backtested for accuracy. Proliferation of
models and metrics, however, make meaningful oversight and enforcement difficult. New
models that produce dramatically lower risk profiles of derivatives trading activity compared to
prior models should be viewed with extreme skepticism by regulators who should require proof
that the lower risk profiles are accurate. Regulators should also respond to evidence of risk
model manipulation with severe consequences.
In addition to risk models, banks should continue to employ such fundamental risk
controls as stop loss limits and concentration limits to curb risky trading. Such controls, when
breached, should be treated as requiring immediate corrective action, rather than casual
conversation or study. Regulators should ensure those risk controls are established, used, and
heeded.
1195 Id. at 116, 118-119.