June 4 (Bloomberg) -- When is a hedge not a hedge?
That’s the question regulators from the Federal Reserve to the Office of the Comptroller of the Currency are confronting after JPMorgan Chase & Co. reported a $2 billion trading loss from a credit-derivatives position Chief Executive Officer Jamie Dimon called a “hedge.”
Regulators are under pressure to respond to JPMorgan’s loss as they finish writing the so-called Volcker Rule, which restricts banks' proprietary trading and is the most controversial provision in the Dodd-Frank Act. They’re scrutinizing the so-called hedging exemption in the proposed regulation and probably will narrow the exceptions for trades banks say are designed to mitigate risk, according to two people familiar with the matter.
JPMorgan’s loss “will reinforce the position of those who want to be tough,” Representative Barney Frank, a Massachusetts Democrat and co-author of the financial-overhaul legislation, said in a telephone interview. “I do think it will mean Volcker will not allow” such trades.
The rule, named for former Fed Chairman Paul Volcker, is intended to reduce the chance that banks will put depositors’ money at risk. Dodd-Frank, signed into law in 2010, largely left regulators to define the provisions, and in October, they released a proposal for the rule, which is scheduled to take effect in July. In April, the Fed said banks would have two years to implement it, as long as they make a “good faith” effort to comply with the ban on proprietary trading.
Pool of Investments
Under the proposed version, bankers would be permitted to do “risk-mitigating hedging activities” for “aggregate positions.” That means using derivatives or other products to reduce the risk of an entire pool of investments, as opposed to a single transaction or position.
The JPMorgan loss has ignited a debate whether aggregate or portfolio hedging is appropriate at all and how to define and spot these trades.
Frank said he hopes regulators will prevent such positions, allowing banks to hedge only against specific investments to offset potential losses.
“Aggregate hedging isn’t hedging, it’s a profit center,” he said. “They are talking about making money out of it,” when “hedges break even.”