I enjoyed Bloomberg’s story about how the SEC was pestering JPMorgan to better disclose its proprietary trading activities well in advance of the London Whale fiasco. If you just read the headline you’d be all “oh look how prescient the SEC was,” but if you read the actual letters, not so much. Here is my favorite exchange:

SEC: Identify the trading desks and other related business units that participate in activities you believe meet the definition of proprietary trading. Identify where these activities are located in terms of your segment breakdowns. Quantify the gross revenues and operating margin from each of these units. We note your disclosure on page 59 of your Form 10-K for the year ended December 31, 2010 that you have liquidated your positions within Principal Strategies in your former Equities operating segment. It is not clear if this was the extent of your proprietary trading business. Please clarify if there are other proprietary trading businesses. If there are, please clearly identify the extent to which such activities or business units have been terminated or disposed of as well as the steps you plan to take to terminate or dispose of the rest of these components.

JPMorgan:1 … The Firm believes that the Staff’s comment regarding the disclosure on page 59 relates to the Form 10-K filed by a registrant other than JPMorgan Chase.

Hahahahaha true, it’s Goldman Sachs.

The more interesting question in this, um, poorly edited form letter that the SEC sent JPMorgan is:

Revise your future filings to clearly identify aspects of your business that are similar to but excluded from your definition of “proprietary trading” for these purposes. Clearly disclose how you differentiate such activities. Tell us the extent to which you believe it is possible that such activities will be scoped into the final regulatory definition of proprietary trading.

I mean, you tell us, SEC! This is really a head-scratcher of a question, is it not? “Tell us what things that you think aren’t prop trading you also think will be prop trading. Also tell us what rules you think we will make.” I guess everyone wants Jamie Dimon’s opinion about everything.

JPMorgan continues to answer in the spirit of “this is dumb but what can you do,” giving a good crisp defense of why (1) market making and (2) structural-hedging-with-a-possibility-of-going-horribly-awry are not “proprietary trading” under the Volcker Rule, followed by a polite form of “but you dopes can do whatever you want so we’ll warn our investors that you might make the wrong decision.”2 It does not, however, make much effort to quantify the revenues in its market-making and Whale-hedging businesses that are at risk if the SEC decides to make a more draconian Volcker Rule. And from subsequent letters it seems like the SEC dropped the issue.

Which is kind of a shame, no? I’m not a big believer in the idea that you can sharply or sensibly delineate bad “proprietary trading” from good … good whatever, “market making” or “hedging” or “long-term financial intermediation like, y’know, lending.” Banks get money and then invest it in stuff; the stuff that they invest in is not rendered more or less risky by calling it “proprietary” or something else. If the Whale wasn’t losing money on CDX curve trades, somebody at JPMorgan would be losing it on mortgage modifications or lending to Greece or whatever.

But the Volcker Rule is happening, probably, so somebody’s gotta do that delineating. And it might be nice to get JPMorgan’s sensitivity table, as it were, about the costs and benefits of bans on various forms of prop-trading-adjacent activity. How much revenue would it cost if, for instance, any mark-to-market profits on market-making were verboten? How much revenue would it cost if Whale-hedging were not allowed? Or, as it turns out, how much revenue would that save?

JPMorgan Pressed by SEC on Prop Trading Before Whale Loss [Bloomberg]
July 1, 2011 from JPMorgan Chase & Co. to SEC [EDGAR]

1. Delightfully this response is in a footnote. In the body of the letter they actually answered the SEC’s question as it applied to JPMorgan, providing a table (unfortunately redacted) of JPMorgan’s prop trading revenues.

ALSO: You’re the SEC, man. This correspondence happened over a year ago and is just being made public now. Wouldn’t you come to an understanding with JPMorgan about editing out this bit of the letter?

2. I mean, you can just read the letter, but here’s the relevant bit:

The Firm does not believe that its client-driven market-making and risk management activities constitute proprietary trading. However, for completeness, we discuss below these activities, which have some features that are somewhat similar to proprietary trading activities, but remain distinguishable based on several important characteristics.

The Firm’s Investment Bank line of business is active in markets for all major financial products in the course of its client market-making and other client-driven activities and actively manages its exposures to credit, interest rate, and other financial risks arising from such activities. While some of these activities require that the Firm take principal positions that, superficially, appear to be similar to proprietary trading positions, they are distinguishable from proprietary trading positions based upon their basic objectives, which are to provide market liquidity and assist clients in achieving their investment and risk management objectives and to manage the resulting risk to the Firm. The Firm’s client market-making and risk management activities are defined by their business mandates and limits, which, together with the risk profiles and other characteristics of the businesses in question (including, for example, the employment of significant numbers of sales staff in the Firm’s client-driven businesses), distinguish these activities from proprietary trading desks.

In addition, the Firm’s Chief Investment Office manages the Firm’s structural risks such as interest rate and foreign exchange risk arising from the assets and liabilities created by its operating businesses. These asset and liability management activities, including securities and loan investment strategies and risk management activities using derivative instruments, are designed to mitigate the Firm’s structural risk exposure and preserve the Firm’s longer-term capital value through economic cycles and, as such, are clearly distinguishable from proprietary trading activity.

The final determination of what is, and what is not, considered proprietary trading for the purposes of the Volcker Rule is heavily dependent on the final content of the Implementing Rules. Certain of the activities that the Firm currently expects to be permitted under the Volcker Rule could be scoped into the definition of prohibited proprietary trading under the final Implementing Rules. However, it is too early to identify definitively activities that may be scoped into the definition of prohibited proprietary trading. Accordingly, in future filings the Firm will include appropriate disclosure of this uncertainty through the inclusion of additional Risk Factor disclosure as further outlined in the Firm’s response to Question 2 of this letter.

19 comments (hidden to protect delicate sensibilities)
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Comments (19)

  1. Posted by Dallas Hedge Fund | December 12, 2012 at 1:08 PM

    I'm surprised JPM had allegedly smart people doing such risky but uncomplicated trades like CDX IG9, a trade that was amended to reduce the impact of the initial intellectual capital's trade. Now here is a fucking trade:

    Try doing a self-tranching, gap-optioned, bifurcated variated non-recourse, debt fronted, knock-out margined index EBITDA "buttress" that ports systemic theta risk on the back of a AAA rated "mosaic" interest rate basis point dispersal -twice a year- as a first derivative supporting an epilated, end-of-day SPV custodial cash sweep of cash-stripped, silo-ed "synthetic suppressed volatility coupons" with exponential yield lock-outs on the benchmarked Libor mezzanine repurposing of pileated iTtraxx "gamma" risk collars spread against "variably constant" price indeterminant debt obligations.

  2. Posted by Sean | December 12, 2012 at 1:19 PM

    But have you ever done that trade…..ON WEED?

  3. Posted by PermaGuestII | December 12, 2012 at 1:20 PM

    That was authentic frontier gibberish!

  4. Posted by Guest | December 12, 2012 at 1:27 PM

    Why didn't you go with the big one?

  5. Posted by 3p14 | December 12, 2012 at 1:41 PM

    Somebody had a little too much fun on investopedia.

  6. Posted by Capt. Obvs. | December 12, 2012 at 1:58 PM

    Dallas, eh? I worked with Highland once or twice, and in my experience Highland is highly correlated with blowhard douche.

    You must work for Highland.

  7. Posted by Matt "cowboy" Levine | December 12, 2012 at 2:14 PM

    All catchy investment words but no charts, or graphs? How equities in Dallas of you.

  8. Posted by Guest | December 12, 2012 at 2:16 PM

    Worst comment since the great Dealbreaker Apocalypse of 12/11/12.

  9. Posted by Guest | December 12, 2012 at 2:30 PM

    "Banks get money and then invest it in stuff; the stuff that they invest in is not rendered more or less risky by calling it 'proprietary' or something else."

    It isn't the "propietary" that is risky, it's the "trading".

    In the bad old days of dinosaurs and financiers with whiskers and floppy disks, banks invested their capital in loans, which have limited downside and whose loss characteristics can be known and effectively tracked over time. In the brave new world of computers and financiers who speak more C++ than English, banks are heavily invested in trading positions with unlimited downside, and whose loss characteristics cannot be known and can change faster than you can say "market break".

  10. Posted by Guest | December 12, 2012 at 2:32 PM

    Continuing my comment since DB won't let me write sequels to "War and Peace" in the comments section . . .

    "How much revenue would it cost if, for instance, any mark-to-market profits on market-making were verboten? How much revenue would it cost if Whale-hedging were not allowed? Or, as it turns out, how much revenue would that save?"

    This isn't about revenue, it's about the survival of the bank. Two hundred years of solid revenue won't save you from one futures trader who has access to the clearance system and uses it to nefarious effect.

  11. Posted by guest | December 12, 2012 at 2:36 PM

    TSDR (too stupid, didn't read)

  12. Posted by NYC Hedge Fund | December 12, 2012 at 2:36 PM

    Try doing a self-tranching, gap-optioned, bifurcated variated non-recourse, debt fronted, knock-out margined index EBITDA "buttress"

    …well I did, and in their cute southern drawl your mom and sister want to know when I come back to Dallas if I could add a "gamma" risk collar to kink it up a bit more.

  13. Posted by Guest | December 12, 2012 at 2:41 PM

    Is whale hedging when you give a whale a handy almost to completion?

  14. Posted by Moby Dickstein | December 12, 2012 at 2:49 PM

    All this whale hedging is making me very nervous.

  15. Posted by Akroyd | December 12, 2012 at 2:54 PM

    Guest, you ignorant slut.

  16. Posted by Guest | December 12, 2012 at 2:57 PM

    Show me a regulatory letter like this and I'll show you a regulator whose disk is full of porn downloads.

  17. Posted by Kanye East | December 12, 2012 at 3:50 PM

    ….and he did it with a hand-bridge

  18. Posted by PermaGuestII | December 12, 2012 at 4:26 PM

    "…whose loss characteristics can be known and effectively tracked over time."

    Weeeelllll…. I wouldn't put too much credence on that whole "things were less volatile in the old days" thing.

    Co-signed-
    Charles T. Barney, President, Knickerbocker Trust Co.
    Roger E. Anderson, Chairman, Continental Illinois Bank & Trust

  19. Posted by guest | December 12, 2012 at 5:50 PM

    Tell me about it

    - Rudolf E.A. Havenstein