Tuesday, July 17, 2012

JP Morgan CIO Loss Update – The Beer Brewer and the Design of the Bottle

When I started writing this post, I had the intention to write about what JP Morgan's CIO had actually traded and how these mechanism work. As you will see, my topic has slightly changed while researching and writing about it.

Last week, JP Morgan has published its 2nd quarter earnings. As its top management had announced to publish details about JP Morgan's recent proprietary trading loss with its 2nd quarter results, I was curious to read the documentation published by the firm last Friday.

The press release seemed promising as it quotes Jamie Dimon saying:

"Since the end of the first quarter, we have significantly reduced the total synthetic credit risk in CIO - whether measured by notional amounts, stress testing or other statistical methods. The reduction in risk has brought the portfolio to a scale that allowed us to transfer substantially all remaining synthetic credit positions to the Investment Bank . The Investment Bank has the expertise, capacity, trading platforms and market franchise to effectively manage these positions and maximize economic value going forward. As a result of the transfer, the Investment Bank's Value-at-Risk and Risk Weighted Assets will increase, but we believe they will come down over time. […] "CIO will no longer trade a synthetic credit portfolio and will focus on its core mandate of conservatively investing excess deposits to earn a fair return. […] The Firm has been conducting an extensive review of what happened in CIO and we will be sharing our observations today.”

Before I continue writing, let me clarify 2 things:

  • First, I don't like power point. The software might be helpful, if it is used as a real support tool for a presentation. However, all too often, it is not used this way...
  • Second, I did not attend the presentations made by JP Morgan executives. Therefore, I must rely on the written material that has been published afterwards. It might be that the oral presentation was perfectly clear. By all means, the published information is not.

Among the supporting documents that the bank has published, my attention was primarily caught by a document called “Presentation Slides - CIO Task Force Update”.

This presentation starts off with a summary of the key takeaways:

  • CIO judgment, execution and escalation in 1Q12 were poor
  • Level of scrutiny did not evolve commensurate with increasing complexity of CIO activities
  • CIO risk management was ineffective in dealing with synthetic credit portfolio
  • Risk limits for CIO were not sufficiently granular
  • Approval and implementation of CIO synthetic credit VaR model were inadequate

Next comes the (much expected) description of the facts:

According to the presentation, the synthetic credit portfolio intended to provide a partial hedge to credit exposures, included long positions to reduce the costs of the credit protection, and was adjusted over time to reflect changes in macro views. During 2007 to 2011, the portfolio steadily generated revenues to JP Morgan's bottom line.

In late 2011, the firm's top management instructed its CIO to reduce the firm's risk weighted assets. My understanding of the presentation is that the firm's CIO did not follow this instruction entirely. It

  • increased net long positions on investment grade indices;
  • increased short positions in some junior tranches for further default protection;
  • continued to increase size in an attempt to balance the portfolio and deal with market and P&L pressures, including perceived vulnerability to other market participants.”

The result was that, by the end of March 2012, the portfolio was exposed to

  • the relationship of Investment Grade to High Yield indices;
  • a default correlation across the capital structure (e.g. super senior vs. mezzanine);
  • the basis risk between off-the-run indices and on-the-run indices.”

Unfortunately, if you had hoped for a more detailed description of what happened (or still happens), you will get disappointed.

From the context of the presentation, you can conclude that the above slide talks about December 30, 2011 and March 30, 2012. Besides the problem of scale in these graphs, we can learn that

  • The long net notional portfolio size tripled: As we know neither the original size nor the exposure, I am not sure that this information is helpful.
  • Notional long net tranche positions tripled: About what tranches are we talking here? What is the original size? What type of exposure are we talking about?
  • Long net notional exposure to off-the-run indices also tripled: What indices are we talking about? Again, what was the original exposure?

Looking and thinking about the above slide, I had a hard time linking the facts to the observations. I tend to think, that, most often, there is simply no relationship at all. My key takeaways from this slide are the following:

  • Instead of reducing the riskiness of the synthetic portfolio, the CIO increased it.
  • The risk limits for CIO were not sufficiently granular, meaning probably that the portfolio was not diversified enough.

At this stage, I still don't know what the famous synthetic portfolio is about. Unfortunately, I will not know it either once I will have finished reading the presentation slides. As a matter of fact, I can read a lot about what CIO has done or should have done, about the risk culture and its implementation, about VaR models and their unsuccessful modification, etc. As an example for this discussion please have a look at the following slide.

Here is a last example of CIO Task Force presentation:

Is there any relationship between the above items? What is the message of this slide, if any?

I must admit that reading the CIO Task Force presentation was not fun. It's actually like listening to a beer brewer talking about any detail of the design of the bottle instead of talking about its content.


  • JP Morgan Press Release dated July 13, 2012
  • JP Morgan - Presentation Slides - CIO Task Force Update - July 13, 2012

Thursday, July 12, 2012

The Shtokman Gas Field Exploration Project

On June 22, 2012, Reuters has reported ongoing negotiations among Gasprom, Total, Statoil and, presumably, Shell, about a new framework agreement for the Shtokman gas project, whose current shareholder pact was about to expire on July 1, 2012.

The project is currently in trouble because the shale gas revolution in the United States will probably make exports of liquefied natural gas to the US unattractive and because the gas consumption in Europe is currently declining, due to the economic downturn.

As I am writing this article, the outcome of these negotiations is still unclear.

Project Timeline

  • 1988: Discovery of the Shtokman gas field
  • July 2007: Signing of a framework agreement between Gasprom and Total
  • October 2007: Signing of a participation agreement by Statoil
  • 21 February 2008: Establishment of the project company “Shtokman Development AG”
  • 2016: Scheduled gas production
  • 2017: Scheduled commissioning of the LNG plant

Geographical, economic and technical aspects

The Shtokman natural gas field, whose initial reserves are estimated at 3.9 trillion m3, is located 550 km from the Russian mainland and situated at a depth level of 340 m.

The project will operate under harsh climate conditions. For example, annual temperatures in the region vary from -50 degree Celsius to +33 degree Celsius.

The intended overall annual natural gas production is 71.1 billion m3. As regards LNG, an annual capacity of 7.5 million tones is envisaged.

Shtokman Development AG

Shtokman Development AG is headquartered in Zug, Switzerland. It is governed by Swiss law. However, as regards the environmental regulation, the Shtokman project is governed by Russian Law. Shtokman Development AG has opened company offices in Moscow, Murmansk, and the village of Teriberka in Murmansk Oblast.

Today, the shareholders of Shtokman Development AG are Gasprom, Total, and Statoil.

The company has currently a nominal share capital of 233 M CHF. Its statutory purpose is to develop and exploit the Shtokman gas and condensate field. As a project company, it will bear all the financial and engineering risks associated with the natural gas recovery and LNG production.

Contracts and Procurement Policy

Shtokman Development AG has put in place a “contracts and procurement policy”. The cornerstones of this policy are the following:

  • The company will develop contracts and purchase orders in a manner that is expected to obtain the lowest total evaluated costs […] with due consideration to health, safety and environment, quality and added value.
  • The contract and procurement function will follow, in full transparency, a reliable and auditable process.
  • A supplier's confidential information shall be protected.
  • It is forbidden to communicate private recommendations to specific candidate firms.
  • Russian contractors and suppliers are given priority, within a sound competitive environment. A specific local content policy has been put in place in this respect.

Local Content Policy

The aforementioned local content policy aims at the development of economics, business, and manpower of the Russian Federation. Its central stipulation proscribes that, when placing orders, Russian suppliers and contractors shall be given a preference if they are comparable with foreign competitors in terms of
  • experience, qualification, and certification;
  • work quality;
  • cost and timing;
  • liability and guarantees;
  • major terms of delivery and performance.

In addition to tapping into existing Russian know how, the local content policy also intends to develop the commercial and industrial know how of Russian companies through the Shtokman project, above all in the the Murmansk region. I should also emphasize that a transfer of knowledge, technologies, and know-how from international companies to Russian ones is expressly mentioned in the local content policy. Finally, the policy also addresses and regulates the tender process for local suppliers.

Ethics Policy

Shtokman Development AG has put in place an ethics policy which is, compared to its other constitutional documents, very detailed. It is basically a list of “Dos” in business including key concepts such as corporate fairness, entrepreneurship, professionalism, high quality business relationships, staff training, integrity, accountability, responsibility, respect, health, safety, protection of the environment, rejection of corruption, transparency, absence of discrimination, permanent dialogue with community groups, avoidance of conflicts of interest, work life balance, and stakeholder engagement.


  • http://www.shtokman.ru/en
  • Extract from the Zug Commercial Register for Shtokman Development AG
  • Shtokman Development AG – Contracts and Procurement Policy
  • Shtokman Development AG – Local Content Policy
  • Shtokman Development AG – Ethics Policy
  • Shtokman Development AG – Stakeholder Engagement Plan
  • Thomson Reuters – Update 2, Talks to save Shtokman gas project go down to wire – June 22, 2012
  • Shtokman Review

Thursday, July 5, 2012

Barclays’ LIBOR / EURIBOR Shortcomings – Part 2 CFTC

Barclays’ Bob Diamond (CEO) and Jerry del Missier (COO) have stepped last Tuesday, due to the ongoing LIBOR / EURIBOR scandal.

I joined Barclays 16 years ago because I saw an opportunity to build a world class investment banking business. Since then, I have had the privilege of working with some of the most talented, client-focused and diligent people that I have ever come across. We built world class businesses together and added our own distinctive chapter to the long and proud history of Barclays. My motivation has always been to do what I believed to be in the best interests of Barclays. No decision over that period was as hard as the one that I make now to stand down as Chief Executive. The external pressure placed on Barclays has reached a level that risks damaging the franchise – I cannot let that happen.
I am deeply disappointed that the impression created by the events announced last week about what Barclays and its people stand for could not be further from the truth. I know that each and every one of the people at Barclays works hard every day to serve our customers and clients. That is how we support economic growth and the communities in which we live and work. I look forward to fulfilling my obligation to contribute to the Treasury Committee’s enquiries related to the settlements that Barclays announced last week without my leadership in question.
I leave behind an extraordinarily talented management team that I know is well placed to help the business emerge from this difficult period as one of the leaders in the global banking industry.”

"My 15 years at Barclays have been a time of great accomplishment, both for me personally and for the bank. I am grateful for the opportunities that were provided to me and proud of what we achieved. We built one of the premier global investment banks from scratch – something that we are all very proud of. The firm is as strong today as it ever has been and is incredibly well placed to succeed within the post financial reform competitive landscape. I have every confidence that the Board and Executive Management of Barclays will be successful in executing their plans, and I wish them the best of luck in doing so."

In this article, I would like to analyze the order of the US Commodity Futures Trading Commission (CFTC) adjudging Barclays to pay a civil monetary penalty of 200 MUSD.


The central stipulations for the FSA fine are the following:

I have discussed the specific obligations that a LIBOR / EURIBOR contributor panel bank must respect, in the previous posts in February 2012.

CFTC’s decision is structured in 3 main parts:


  • Barclays, through the acts of its swaps traders and submitters, made false LIBOR reports and attempted to manipulate LIBOR. / Barclays attempted to manipulate EURIBOR, made false EURIBOR reports and coordinated with other banks in its attempts to manipulate EURIBOR.

The CFTC first describes that the persons in charge of submitting Barclays’ LIBOR and EURIBOR rates were very experienced employees, having 25 years and 20 years of experience in the respective money markets. These people acted in an environment that Barclays had not regulated internally: “Barclays did not have specific internal controls or procedures, written or otherwise, regarding how LIBOR / EURIBOR submissions should be determined or monitored. Barclays also did not require documentation or the submitters’ LIBOR determinations.”

The order then describes how Barclays' swap traders influenced Barclays' LIBOR / EURIBOR submitters on a regular basis in order to manipulate the respective base rate. It emphasizes that such attempts were common practice and publicly discussed among swap traders before contacting the submitters: “In fact, traders would often shout across the trading desk to fellow traders to confirm there were no conflicting requests before they sent their requests to the EURIBOR submitters, and, on occasion, the traders discussed their requests with trading desk managers.”

Next, the CFTC mentions that Barclays' swap traders also acted repeatedly on behalf of external (former Barclays) swap traders when trying to manipulate the respective base rate.

Many examples of communications between swap traders and submitters are cited, outlining clearly the ongoing collusion. The examples resemble pretty much those that I have cited in my last post on the FSA's fine on Barclays.

  • During the financial crisis, Barclays senior management directed that LIBOR submissions be lowered.

The CFTC first describes the illiquid situation in the London inter-bank money market during the financial crisis. It then goes on by outlining the position that Barclays' LIBOR submitter had taken during that time: As a matter of fact, he had expressed his view that, given the illiquid situation in the money market, Barclays' submissions were “unrealistically low”. However, the quotes of other participating banks being still lower and, therefore, even more unrealistic, he concluded that “if [Barclays] were to submit higher, accurate LIBORs / EURIBORs, then the market or press would report that Barclays was experiencing difficulty in funding itself”. The CFTC emphasizes the negative media coverage on Barclays' constantly higher LIBOR submissions.

To Barclays' discharge, the CFTC recognizes that “certain senior managers within [Barclays] instructed the USD LIBOR submitters and their supervisor to lower Barclays' LIBOR submissions, so that they were closer in range to the submitted rates by other banks but not so high as to attract media attention”. In addition, according to the CFTC, these senior managers “frequently discussed with the USD LIBOR submitters and their supervisors the specific rate to be submitted, in order to ensure they were in compliance with the directive”.

Another important aspect in this section is the fact that BBA representatives and FSA stuff members were in contact with Barclays senior treasury managers at that time and discussed the artificially low rates of certain panel banks. However, according to the CFTC, “Barclays did not disclose at this time that is was lowering its LIBOR submissions pursuant to a management directive”.

Barclays treasury manager: “We're clean, but we're dirty-clean, rather than clean-clean”.

BBA representative: “No one's clean-clean”.

The issue of Barclays submitting patently false rates was raised to the compliance function at that time. Nevertheless, the compliance officer in charge did not follow up internally on this issue.

It should be noted that the allegation of lowering base rate submissions only challenges Barclays' LIBOR submissions; no similar allegation is made in relation to EURIBOR submissions.

Legal Discussion

  • Barclays made false, misleading or knowingly inaccurate reports concerning the costs of borrowing unsecured funds.
  • Barclays attempted to manipulate LIBOR and EURIBOR.
  • Barclays aided and abetted the attempts of other traders at other banks to manipulate EURIBOR.
  • Barclays is liable for the acts of its agents.

CFTC’s legal discussion is quite short. The emphasis in this case is clearly on the factual side and the legal appreciation is not a major concern here.


  • Barclays shall cease and desist from violating the Commodity Exchange Act.
  • Barclays shall pay a civil monetary penalty of 200 MUSD.
  • Barclays shall comply with specific conditions and undertakings: The CFTC strives to protect the integrity and reliability of Barclays’ future benchmark interest rate submissions by describing detailed rules of how submissions shall be determined, how supervisions, monitoring, and auditing shall be carried out, and how internal firewalls shall be put in place.


  • CFTC order No. 12-25 dated June 27, 2012

Monday, July 2, 2012

Barclays’ LIBOR / EURIBOR Shortcomings – Part 1 FSA

In February, expanding on the ongoing press coverage of possible LIBOR and EURIBOR manipulations, I have written about the functioning of these base rates.

As the UK Financial Services Authority (FSA) and the US Commodity Futures Trading Commission (CFTC) have inflicted, on June 27, 2012, a 59.5 M Sterling / 200 M USD fine on Barclays for its shortcomings relating to LIBOR / EURIBOR submissions, I would like to come back to this topic.

Chairman Marcus Agius having resigned today, the consequences for Barclays are still ongoing.

Last week’s events – evidencing as they do unacceptable standards of behavior within the bank – have dealt a devastating blow to Barclays’ reputation. As chairman, I am the ultimate guardian of the bank’s reputation. Accordingly, the buck stops with me and I must acknowledge responsibility by standing aside.”

In this post, I would like to discuss the FSA fine and its rationale.


The central stipulations for the FSA fine are the following:

I have discussed the specific obligations that a LIBOR / EURIBOR contributor panel bank must respect, in the previous posts in February 2012.

Barclays LIBOR / EURIBOR Violations

In its final notice, the FSA accuses Barclays of having violated the above stipulations by executing 4 activities:

1. Violation of FSA principle 5 through inappropriate submissions following requests by Barclays’ and third party banks’ derivatives traders

In my view, this part of FSA’s final notice is the most interesting and best justified part of its decision.

As the FSA clarifies, “the definitions of LIBOR and EURIBOR do not allow for consideration of derivatives traders’ positions.” In case of LIBOR, the definition specifically provides for this fact. In case of EURIBOR, this applies naturally because a submission influenced by derivatives’ traders would obviously reveal a conflict of interest. As a matter of fact, Barclays’ derivatives traders trade OTC interest rate swaps and exchange traded interest rate futures whose payment obligations are oftentimes based on LIBOR or EURIBOR.

The FSA cites many examples of email / chat exchanges between Barclays’ derivatives traders and LIBOR / EURIBOR submitters:

Trader C: “The big day [has] arrived… My NYK are screaming at me about an unchanged 3m libor. As always, any help wd be greatly appreciated. What do you think you’ll go for 3m?”

Submitter: “I am going 90 altho 91 is what I should be posting”.

Trader C: “[…] when I retire and write a book about this business your name will be written in golden letters […]”.

Submitter: “I would prefer this [to] not be in any book!”

Trader F: “Pls set 3m libor as high as possible today.

Submitter: “Sure 5.37 okay?”

Trader F: “5.36 is fine”

In addition, to these striking individual cases, FSA’s investigations have shown that at least 70 % of derivatives traders’ LIBOR requests and at least 86 % of derivatives traders’ EURIBOR requests were followed by submissions consistent with such requests.

The FSA goes on concluding that the above described misconduct at Barclays was common and nearly daily practice over a number of years.

2. Violation of FSA principle 5 through inappropriate submissions to avoid negative media comment

When the financial crisis was, between end of 2007 and mid 2009, at its peak level, banks’ liquidity was a particularly important issue. At that time Barclays posted significantly higher LIBOR / EURIBOR rates than its peers. As this fact caused negative publicity for Barclays, the bank felt pressure to submit lower rates. The FSA puts it very nicely:

“Senior Management at high levels withing Barclays expressed concerns over this negative publicity. Senior Management’s concerns in turn resulted in instructions being given by less senior managers at Barclays to reduce LIBOR submissions in order to avoid negative media comment.”

However, reading through this passage of the final notice, I must admit that FSA’s reasoning is much less convincing here.

As a matter of fact, the FSA outlines that Barclays had raised general concerns with the regulators about the accuracy of LIBOR submissions.

In addition, it mentions that interbank-lending was pretty much limited during that time. As a consequence, a correct price finding was certainly very tough, if not impossible. In my view, there is a natural tendency in such an illiquid market to set prices according to those set by peers, and Barclays can only hardly be blamed for this.

Reading through this passage of FSA’s decision, I miss a clear demonstration of what Barclays’ specific wrongdoings consisted of. It seems more that the bank followed the other contributing banks than leading the process itself.

3. Violation of FSA principle 3 through systems and control failings

Until December 2009, Barclays had no specific systems and controls in place relating to its LIBOR and EURIBOR submissions processes. The FSA blames Barclays for this lack all the more as the bank had repeatedly received proposed methodologies and draft procedures for LIBOR submitters by BBA’s FX & MM Committee as well as a reminder by EURIBOR regulator EBF to ensure and maintain a systematic and close control of the bank’s daily quotations.

4. Violation of FSA principle 2 through compliance failings

The FSA describes in its decision that LIBOR issues have been escalated to the bank’s compliance functions on 3 occasions and that compliance did not react appropriately. More specifically,

“in September 2007, senior management flagged the potential conflict of interest between Barclays’ submitters and derivatives traders. This and other concerns were escalated to Compliance. Compliance did not discuss these issues with the Submitters and did not draft any policies or procedures relating to this conflict of interest.”


  • Financial Services Authority – Final Note Ref. 122702 dated June 27, 2012