London Whale Presentation

1. JPMorgan & the London Whale
Presented by Joey Froehlich and Laura Tack

2. Case Summary
●JPMorgan had a Synthetic Credit Portfolio (SCP) that experienced a lot of
growth from 2011 to 2012.
●For SCP, JPMorgan invested in both High Yield and IG investments.
●High Yields are high risk, IGs are low risk.
●Protection was purchased for both HY and IG.
●IG protection was sold and the proceeds were used to pay off the protection
for HY.

3. Case Summary Cont.
●A lot of IG investments ended up performing poorly.
●Proceeds from HY investments could not make up for losses on IG.
●In response, metrics used to assess risks were adjusted.
●VaR and CSBPV limits were also adjusted to make it look like SCP was
performing well.
●SCP was in a position where it could not back out, so it continued to grow.

4. Case Summary Cont.
●SCP growth:
○2011:
■$4 billion to $51 billion
●SCP proceeds and losses:
○Proceeds:
■$1 billion in 2011 with $400 million in derivatives
○Losses:
■2012
●January: $100 million
●February: $69 million
●March: $40 million
●March 23, Ms. Drew ordered “Phones Down.”

5. Risk Management Framework
●VaR:
○Estimates possible magnitude of decrease in value of financial instruments over a fixed time
period.
○Calculated with either historical market data or Monte Carlo simulation.
○Useful for monitoring market risk.
○Limitations:
■Used to analyze credit indices.
■Relies on analysis of correlation between underlying assets, which is subjective.

6. Risk Management Framework Cont.
●CSBPV
○Measures price sensitivity for each basis point change in credit spread.
○Useful in estimating impact credit spreads have on small moves.
○Limitations:
■Cannot accurately account for convexity.
■Not good for when large moves happen in the market.
●CSW10%
○Measures expected change in portfolio value if credit spread on each position is widened by
10%.
○Useful for stress testing portfolios.
○Trusted by Ms. Drew.
○Not subject to limitations of other two metrics.

7. Appropriate type of Exposure
●For this case, Gross exposure is more appropriate:
○“Indicates total exposure to financial markets, thus providing an insight
into the investment amount at risk from market fluctuations”
(Investopedia, 2016).
○Can comprise value of short and long investments.
○Useful because SCP uses both short and long investments.
○Can provide important insight for risk management.

8. RWAs
●Different types of derivatives should be regarded as separate RWAs.
●Multiple types of investments can have different levels of risk.
●These differing levels of risk can lead to diverse characteristics.
●Such diversity can lead to different effects on other assets.
●If each derivative has its own RWA, the risk of SCP can be assessed more
accurately.

9. Cash Management
●Derivatives can be employed in this function.
●Cash management was not tempered by risk management function.

10. Mistakes Made by the CIO Team
●The CIO team emphasized maintaining profitability more than it emphasized
risk management
○The profitable 2011 American Airlines bankruptcy incentivized the CIO team to maintain RWA
exposure
○The CIO team executed trades that were speculative in nature
■Bruno Iksil, the senior trader of the SCP, bought protection on riskier credit indices and
sold protection on the less risky credit indices
■Abandoned the CIO’s traditional longer term, hedging-oriented investment approach

11. Mistakes Made by the CIO Team, cont.
●The CIO team responded to losses by doubling down on their losing strategy
○Losses in the long IG protection could not be counterbalanced by the gains in the short HY
exposure
○JPM could not reduce their exposure
■Illiquid credit market
■High investment in the market
○The CIO team responded by increasing both long and short exposure

12. Mistakes Made by the CIO Team, cont.
●The CIO team engaged in unethical practices to hide their problems
○Created a new VaR model that lowered both the stated risk and the RWA
■Successfully fought to have the approval process inappropriately expedited
○Did not adequately inform JPM senior management or regulators of the SCP’s problems
○Departed from U.S. Generally Accepted Accounting Principles in order to account for their
derivatives more favorably

13. Risk Management
●Inadequacies
○Dismissal of VaR and CSBPV metrics by management
■Ina Drew, the Chief Investment Officer, ignored all metrics but the CSW10%
■Higher management, such as Jamie Dimon, approved temporary bankwide metric limit
increases to end breaches caused by the SCP
○ Lack of limitation on the market value of the SCP
●Recommendations
○Utilize the CSW10% alongside other risk metrics and give them importance
○Implement a limit on the market value of the SCP
○Prevent individual employees from overriding policies
■Risk metrics
■U.S. GAAP

14. Organizational Structure
●Inadequacies
○Inherent conflict of interest
■Drew was responsible for both trading and risk management
○Management did not exercise proper oversight of subordinates
■Risk metric breaches and alterations
■Accounting inconsistencies
■Reports to management
●Recommendations
○Hire a more experienced Chief Risk Officer and give this position the responsibility for risk
management
○Management should monitor the actions of subordinates more closely

15. Citigroup Inc.
●Citigroup has been buying risky derivatives in bulk
○2009 - Citibank, Citigroup’s primary banking subsidiary, had $32 trillion in derivatives (Eavis, 2015)
○2014 - Citibank had $70 trillion in derivatives (Eavis, 2015)
○2015 - Citigroup bought credit derivatives ($250 billion notional value) (Griffin & Voegeli, 2016)
○2016 - Citigroup bought credit derivatives ($380 billion notional value) (Griffin & Voegeli, 2016; Whittall, 2016)
●Experts say Citigroup does have the capital necessary to mitigate the risk associated with these
derivatives (Eavis, 2015)
●It appears that Citigroup’s motive in investing in these derivatives is profit-related
○Citigroup’s investment bank has begun generating much higher profits than its consumer bank (Eavis, 2015)
○Citigroup successfully lobbied to weaken aspects of the Dodd-Frank law that apply to derivatives (Eavis, 2015)

16. Citigroup Inc., cont.
●If Citigroup wishes to avoid a catastrophe such as the one experienced by
JPMorgan, it must:
○Ensure its organizational structure does not create conflicts of interest
○Ensure it does not purchase an unwieldy share of the credit derivative market
■Many banks are currently shedding derivatives in order to conform with Basel III
■Citigroup must be especially vigilant in monitoring how much of the market they own
○Actively monitor its risk metrics
○Ensure compliance with all governmental regulations and accounting principles related to
derivatives

17. References
●Eavis, P. (2015). Citigroup’s Roaring Revival on Wall Street. The New York Times. Retrieved from
http://www.nytimes.com/2015/03/11/business/dealbook/citigroups-roaring-revival-on-wall-street.html

●Griffin, D. & Voegeli, J. (2016). Citigroup Said to Purchase CDS Portfolio From Credit Suisse. Bloomberg Markets.
Retreived from
https://www.bloomberg.com/news/articles/2016-08-05/citigroup-said-to-buy-derivatives-portfolio-from-credit-suiss
e

●Investopedia. (2016). Gross Exposure. Retrieved from
http://www.investopedia.com/terms/g/gross-exposure.asp?lgl=no-infinite

●Wittall, C. (2016). Credit Suisse Sells Credit Derivatives Portfolio to Citigroup. The Wall Street Journal. Retrieved from
http://www.wsj.com/articles/credit-suisse-sells-credit-derivatives-portfolio-to-citigroup-1470414328