JPMorgan – It’s a risky business!

The recent announcement that a failed hedging strategy by JP Morgan’s Chief Investment Office in London had cost the firm $2 billion has once brought the issue of risk governance to the fore.

Subsequent to the financial crisis of 2008-2009 precipitated by deficient risk governance and management, the Dodd-Frank financial regulatory overhaul required major financial institutions to ensure boards take ownership of the risk process and have a risk management committee that oversees activities within the bank. The Federal Reserve proposed supplementary rules to implement the provision which included for a requirement that at least one member of the committee is a risk management expert – but these have yet to be incorporated.

Here in South Africa, both requirements have been incorporated into the King Report on Governance 2009 (King III) calling firstly for the Board to take responsibility for the governance of risk through formal processes which include the total system and process of risk management. As far as membership of the committee goes, this should comprise people with adequate risk management skills and experience to equip the committee to perform its functions. To supplement its risk management skills and experience, the risk committee may invite independent risk management experts to attend its meetings.

The issue of risk committee membership is at the core of the JP Morgan loss according to the CtW Investment Group, a labour-backed shareholder group, who last year raised its concerns with JPMorgan around the composition of the committee’s membership. The group raised concerns specifically around the credentials and skills of one of the three members of the risk committee on JPMorgan’s board who happened to be a director at American International Group Inc (AIG) before its collapse and government bailout in the 2008 financial crisis.“We are deeply concerned that the current three-person risk policy committee, without a single expert in banking or financial regulation, is simply not up to the task of overseeing risk management at one of the world’s largest and most complex financial institutions,” a 1 April 2012 letter from CtW said.

I think that it is worthwhile noting that the quality of a risk management function is determined from the outset by its board of directors. Without an active voice from the top supporting a strong risk management culture, risk management has little chance of off-setting risky strategies that are formed outside the firm’s risk appetite. In the case of JPMorgan, there is a growing concern that it seems less likely that they did not support risk management, but they had little expertise to know what risk management entails.

This can certainly be attested to through the assessment of GMI Ratings, a corporate governance analyst, who gave its lowest mark – an “F” – to JPMorgan’s corporate governance policies in general prior to the disclosure of the loss, Reuters reported. Of more significance than the rating itself is that fewer than five percent of the companies rated by GMI get the bottom ranking, said Paul Hodgson, senior research associate at the GMI.

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