The JPMorgan Chase & Co. unit that lost more than $2 billion through a failed hedging strategy had looser risk controls than the rest of the bank, according to people familiar with the situation.
The risk of losses is tallied by the bank using a so-called value at risk calculation. However, the Chief Investment Office, the unit responsible for the high-profile loss that JPMorgan disclosed last Thursday, had a separate VaR system.
It used a less stringent calculation that gave a lower risk assessment of its trades, according to people who previously worked at the bank.
The unit also reported directly to CEO Jamie Dimon, a factor which allowed it to maintain a separate risk monitoring set-up to other parts of the investment bank, these people said.
Despite repeated warnings from executives inside the firm as long ago as 2005, the CIO unit remained notably free from oversight.
A source with knowledge of the situation said that these warnings included the size of the CIO, the fact that its risk reporting was not transparent and the scope for the unit to get “bigger and bigger” because it had a lower cost of funding than the rest of the investment bank.
Until April, the CIO unit’s unusual autonomy allowed it to build up risky positions without triggering alarms.
Indeed, the unit was encouraged to be a profit centre, as well as hedging against risk, a source with direct knowledge of the unit said. Ina Drew, who headed the unit, earned more than $15 million in each of the past two years, making her among the highest-paid executives at the bank and one of the most compensated women on Wall Street.
“It created incentives to take extraordinary risk in one pocket of the bank” that was different from the rest, the source said. “If someone’s getting paid $15 million, it’s a profit centre.”
While the bank didn’t completely ignore risks at the unit, any assessment can overlook problems if it is measuring risk with the wrong yardstick.
When reports surfaced last month that one of JPMorgan’s CIO unit traders in London had taken a huge position in credit derivative markets, JPMorgan officials were prompted into taking a closer look at the risk in the CIO unit, banking sources, including a former CIO employee, told Reuters.
About two weeks ago, the bank finally applied its more stringent risk model to the CIO’s trades. It got a nasty surprise: the model revealed that the maximum amount the CIO could lose in a single day had soared, one of the sources said.
Recent regulatory filings illustrate the rise in risk. A filing from April 13 showed a daily VaR for the CIO unit of $67 million. But a May 10 filing, showed it had risen to $129 million. That means the amount the unit could lose on most days had nearly doubled, and on some days it could lose much more.
By the time the increase was discovered, its positions had grown to a size that made it impossible for the bank to quickly unwind the trades, the sources said.