July 25th, 2014
On the fourth anniversary of the Dodd-Frank Act, the big US banks are still black boxes in terms of their trading activity. However regulators are now getting a bit more information. Over the last month, the big banks have started providing them with so-called reporting metrics under the Volcker Rule, so that the rule’s curbs on proprietary trading can be enforced.
This is a big deal, so it’s worth going through it in some detail. Who are the regulators that get the information? There are four of them – the Fed, the Office of Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Securities & Exchange Commission. Who are the banks covered by the first wave of the rule? There are nine of them that have trading assets above the $50 billion threshold – banks like JPMorgan, Goldman, Morgan Stanley, Bank of America and Citigroup.
Compiled at the trading desk level, there are seven types of metric that have to be provided to regulators, including position limits, risk factor sensitivity, value-at-risk/stress VaR, P&L attribution, inventory turnover/age and customer-facing trade ratio.
How many trading desks are there? We don’t know precisely how the banks and regulators will agree to split them out, but PWC estimates that each of the nine banks has between 50 and 125 of them. There are the main asset classes – equities, fixed income, commodities, each of which might be subdivided geographically or by subcategory, and other stuff such as mortgage servicing rights or credit valuation adjustment hedging. Each desk at each bank has to supply the seven reporting metrics to each regulator.
Like the old children’s rhyme about meeting a man on the way to St Ives, the combinatorics soon gets frightening, and helps explain why the big banks have spent billions and hired tens of thousands of new compliance staff. The regulators too have boosted their numbers, with the Fed and OCC adding about 2,000 staff between them since 2010.
Remember that these numbers are good news. Back in 2008, the big banks were all making huge proprietary bets, the regulators were clueless and the financial system nearly collapsed as a result. From this year onwards, with all these Volcker restrictions and monitoring, there should be no excuse. We can hope that the regulators will know how to sift through the mass of data, and will be prepared to argue with banks about things like ‘reasonably expected near-term demand’ for credit swaptions or whatever a desk is accumulating on its books.
Yet if history is anything to go by, there is always the possibility that they won’t know what to do or will shy away from doing it. That’s why I would like the regulators and those who watch over them in US Congress to push things a little further. What they should be doing is finding a way to make some of those Volcker metrics public.
You might ask whether the big US banks don’t already put enough information in the public domain. Don’t they already publish quarterly earnings supplements and SEC filings that run to hundreds of pages? Don’t we already get those profit/loss attributions and VaR numbers?
My response is that while we do get some information from the banks, it’s not nearly sufficient to understand what is happening in their trading businesses. For a start, VaR is only reported at a very high aggregate level, covering entire asset classes compiled from dozens of trading desks. And even then, there’s the possibility that they have calculated the metric wrongly, as JPMorgan did with its London Whale trades. Only by getting multiple metrics at a more granular level can outsiders understand what banks are actually doing.
Without that, we have to rely on ‘guidance’ – what the banks choose to tell us when they explain their disclosures. That’s what Citigroup did with its latest results, where it lost $100 million as a result of what it described as over-aggressive hedging in response to the Ukraine crisis. Presumably Citi thought that was too big to sweep under the carpet.
But what are we to make of this exchange between JPMorgan CEO Jamie Dimon and analyst Mike Mayo on 15 July:
Q – Mike L. Mayo: First, why did trading do better than the guidance earlier in the quarter? And did that relate to the 8% increase in trading VaR, which was a little surprising since volatility is still so low?
A – Jamie Dimon: The VaR jumps around, but some of that jumping around is really think of underwriting positions, CMBS, warehouse positions and stuff like that which come and go.
Q – Mike L. Mayo: Okay. I always prefer more guidance than less.
The key words in Dimon’s nothing-to-see-here answer are ‘underwriting’ and ‘warehouse’. Clearly JPMorgan took on some additional risk because it had some customers lined up, and made some extra money. But what if conditions changed and the customers backed out? To avoid a prop trade, it would have had to sell at a loss.
With Volcker metrics disclosed at the trading desk level, outsiders would have a much better understanding of risk taking at JPMorgan and other too-big-to-fail banks.
Now the banks would might respond by saying that too much disclosure would reveal their positions to hedge funds which could front-run them. But that could be dealt with using a time lag. For example, disclosures in 10-Q filings appear about 5-6 weeks after quarter end. And the banks already have provided additional disclosure in the last few years, such as sovereign debt positions in response to concerns over their Eurozone exposure. A little more shouldn’t hurt them.
So is there any chance of this actually happening? One person that did ask the question about public disclosure was former Fed governor Sarah Bloom Raskin at a hearing on 10 December 2013. According to lobby group SIFMA, which attended the hearing, Raskin questioned staff on whether there was “any value in developing a disclosure regime that reveals to the public, the nature of trading activity at banks and that demonstrates, clearly, how such trading activity may be complying with the Volcker Rule.”
This was the answer from Fed staff: “I don’t think we have anything in the rule that would provide for public disclosure of the amount of trading that’s occurring in that vein.”
Is that the end of the matter? In March, Raskin was confirmed in a new role as Deputy Secretary to the US Treasury. That should put her in a good position to revisit the issue with the same regulators, hopefully with some congressional backing.