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

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If the SCP had used credit derivatives as dedicated hedges, it should have triggered the
bank’s standard hedging documentation procedures, at least in later years. JPMorgan Chase’s
2011 annual report stated, for example, that the bank had a detailed set of internal procedures for
tracking derivatives used as hedges:
“For a derivative to be designated as a hedge, the risk management objective and
strategy must be documented. Hedge documentation must identify the derivative
hedging instrument, the asset or liability or forecasted transaction and type of risk
to be hedged, and how the effectiveness of the derivative is assessed prospectively
and retrospectively. To assess effectiveness, the Firm uses statistical methods
such as regression analysis, as well as nonstatistical methods including dollarvalue
comparisons of the change in the fair value of the derivative to the change
in the fair value or cash flows of the hedged item. The extent to which a
derivative has been, and is expected to continue to be, effective at offsetting
changes in the fair value or cash flows of the hedged item must be assessed and
documented at least quarterly. Any hedge ineffectiveness (i.e., the amount by
which the gain or loss on the designated derivative instrument does not exactly
offset the change in the hedged item attributable to the hedged risk) must be
reported in current-period earnings.” 286
Those procedures were used by the bank to qualify its hedges for favorable accounting treatment,
but the annual report does not indicate that those procedures applied only to those types of
hedges that received favorable accounting treatment. At the same time, despite this detailed
description, JPMorgan Chase has not identified any CIO documentation indicating that credit
derivatives in the SCP were subjected to any of the analysis or documentation described above.
Macro Hedge. A number of bank representatives told the Subcommittee that the SCP
was intended to provide, not a dedicated hedge, but a macro-level hedge to offset the CIO’s $350
billion investment portfolio against credit risks during a stress event. 287 In a letter to the OCC
and other agencies, JPMorgan Chase even contended that taking away the bank’s ability to
establish that type of hedge would undermine the bank’s ability to ride out a financial crisis as it
did in 2009. 288 The bank also contended that regulators should not require a macro or portfolio
hedge to have even a “reasonable correlation” with the risks associated with the portfolio of
assets being hedged. 289
The counter to this argument is that the investment being described
286
JPMorgan 2011 Annual Report, at 202-203.
287
Subcommittee briefing by JPMorgan Chase (8/15/2012) (Greg Baer, Chetan Bhargiri); Subcommittee interview
of Jamie Dimon, JPMorgan Chase (9/19/2012) (stating that the synthetic credit portfolio was a “fat tail hedge”
against the CIO’s investment portfolio, which would also benefit the bank generally); Subcommittee interview of
Ina Drew, CIO (9/7/2012) (explaining that the SCP’s purpose when it was established was to hedge firmwide risk,
but then changed to hedge the CIO’s investment portfolio against credit risks during a stress event); Subcommittee
interview of John Wilmot, CIO (9/11/2012); Subcommittee interview of Douglas Braunstein, JPMorgan Chase
(9/12/2012); Subcommittee interview of John Hogan, JPMorgan Chase (9/5/2012) (characterizing the SCP as a
hedge against macro credit risk).
288
See 2/13/2012 letter from JPMorgan Chase, to Department of the Treasury, Board of Governors of the Federal
Reserve System, Federal Deposit Insurance Corporation, Securities and Exchange Commission, and Office of the
Comptroller of the Currency, “Comment Letter on the Notice of Proposed Rulemaking Implementing Section 619 of
the Dodd-Frank Wall Street Reform and Consumer Protection Act,” at 56-57.
289
Id. at 25.