Shipkevich Bitcoin and ICO Attorney
Felix Shipkevich May 15, 2012
Paul Volcker

Amid the barrage of analysis of JPMorgan’s announcement last week of a $2 billion trading loss by the firm’s Chief Investment Office, one factor in its implications is how hedging should be defined.

By definition, it is impossible for a perfect hedge to result in either a loss or a gain. Real world hedging, however, is not as clear-cut as it is in textbook examples. When it is done through synthetic positions in particular, the greater number of moving parts increases the chance that something will go wrong. According to Paul Hsi, head of United States credit research at Morgan Stanley, “The idea of risk management is an oxymoron. You can try to measure the amount of potential risk in your portfolio, but the only way to really ‘manage’ risk is by either taking more of it or less of it.”

The nuances of what hedging may or may not be makes it difficult to draft good regulations that depend on the distinction. For example, experts have been disagreed over whether the position that lost JPMorgan $2 billion would have been banned under the Volcker Rule.

On the other hand, it is not enough to say that the semantic difficulties mean that JPMorgan did nothing wrong. Reports coming out of the company say that the CIO, which conducted the trade in question, has increasingly been a source of profit for JPMorgan while officially keeping its official risk management function. The lesson of the JPMorgan loss may be that what defines hedging is not some esoteric definition, but the intent of traders and their supervisors.

Read more about the difficulty of defining hedging, and what it means for regulation.

 

Photo credit: Harvard Ethics