The synthetic credit portfolio, which consisted of illiquid off-the-run credit default swap index trades, cost the bank in excess of US$6bn after the positions were revealed in May last year. The debacle claimed the jobs of a number of senior employees including the division’s credit head, Bruno Iksil, dubbed the “London Whale” and former CIO head Ina Drew.
JPMorgan CEO, Jamie Dimon, escaped the axe, though his bonus for 2012 was halved to US$10m, taking his total remuneration to US$11.5m compared to US$23m in 2011.
According to the report, a number of errors in a new risk model that was introduced in the first quarter of 2012 served to mute volatility by a factor of two, artificially lowering the VaR figure, something Dimon originally alluded to when announcing the losses last May.
In addition, the model included an error in its default setting for the calculation of hazard rates and correlation – something that was investigated by a JPM employee and ultimately led to the discovery of the additional problems.
Under the new methodology, VaR for the unit was calculated at an average of US$67m for the first quarter of 2012 – broadly in line with the 2011average of US$60m calculated under the previous model.
However, on discovery of the errors, the CIO reverted back to the old model in the second quarter, causing VaR to almost double to US$129m.
In its report, intended to investigate events leading up to the debacle that resulted in a US$6bn loss for the US dealer, the task force noted a number of key areas in which the bank is undertaking significant remedial action, including substantial reform of its model risk policy, governing development, review, approval and monitoring of models.
The model implemented in early 2012 was intended to provide more accurate calculations of statistical risk under Basel 2.5. According to the report it was introduced in late January after the CIO breached its risk limits on multiple days earlier that month.
An initial attempt was made to resolve the breach by reducing the risk profile of the portfolio, and a temporary increase in the firm-wide VaR limit from US$125m to US$140m was approved by Dimon in late January. At the same, CIO head Ina Drew approved a temporary limit increase to US$95m for that division.
Expiration of the temporary increase was set to coincide with the introduction of the new model, which was eventually approved by the bank’s model review group on January 28.
Additional measures taken following the losses include an overhaul of CIO management and mandate.
Under the leadership of Matthew Zames, the CIO has refocused on traditional asset-liability management. The unit, which managers around US$400bn of deposits, now remains invested in assets with an average AA+ rating, while any future synthetic credit positions will be expressly linked to a particular set of risks.
The risk function within the CIO has also been overhauled with revised limits and the introduction of granular and portfolio-level limits.
