With the recent $2 billion+ debacle of JPMorgan Chase & Co.’s losses, it has given the supporters of Dodd-Frank enough fodder and support for the argument of increased documentation for processes and controls. These three areas of controls are: 1) understanding your exposure 2) documenting the decisions — not just the underlying exposures, but also the subsequent risk management decisions made in order to mitigate that risk, and 3) developing an appropriate risk mitigation strategy.
So, let’s delve deeper into to these areas of controls, as well as review what has been learned as a result of this loss:
1) Understanding Your Exposure
It is still unclear whether the underlying risks were appropriately assessed, especially given the fact that any risk mitigation strategy was likely going to bump up against liquidity capabilities and was likely only measured with a 95% confidence factor, the combination of these aggressive assumptions led to a risk assessment of only $65 million. Clearly the exposure was ill-defined.
2) Documenting the Decisions
Dodd-Frank is looking to improve documenting decisions for the purpose of not just being able to retrace bad decisions, but to create processes where organizations within companies and outside auditors can continue to follow the underlying exposures and the directly related mitigation strategy. In addition, improvements need to be made as it relates to checking what the risk mitigation strategy has been, to see if this is appropriately in line with expectations.
3) Developing a Risk Mitigation Strategy
It is clear now that the risk mitigation strategy in place appears to have been inappropriate in various areas. It is also clear that the risk of the underlying exposure appears to have been opaque, and not well enough defined. Overall, this situation is very disappointing, and many market participants view this an unfortunate event that is very untimely in supporting yet another layer of regulations.
— Wolfgang Koester
Wolfgang Koester is the CEO of FiREapps, the leading provider of foreign currency exposure management software, based in Scottsdale, AZ. He has managed risk for Fortune 100 companies as well as governments, including G-10s, since 1986. To learn more about FiREapps, go to www.fireapps.com.