Counterparty Risk Thrust Back in Spotlight After JP Morgan Loss

Despite the ruckus over new banking regulations, investors should not think these 'trusted partners' are 100% safe, market specialists have been warned.

(May 14, 2012) — Counterparty risk is still a clear and present danger, investors have been warned, as yet another investment bank falls foul of internal risk management processes.

Market participants have urged investors to remember that investment banks are present on almost every step of their investment process, and are still fallible in spite of changing regulations and government pressure.

The Head of Distribution at a large global custodian told aiCIO: “Investors are exposed all the way down the chain – if they are trading, even custodians have capital market divisions – and it is seemingly random when these things will blow up.”

He said: “Capital rules have been tightened up, but by the time they come into effect it will be 10 years down the line – this is too long a process, and the banks are resisting all the way.”

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Counterparty risk was first brought to the top of investors’ agendas in 2008 with the collapse of Lehman Brothers. Positions held within the bank’s prime brokerage unit could not immediately be traced and those using the bank as a counterparty for swaps and hedges found themselves unstuck, or unable to close out positions.

Investment banks have long had relationships, direct and indirect, with the end investors, but with the trend for hedging of interest rates, inflation and longevity these bonds have become even more tightly knit.

“The question isn’t ‘Have they tanked?’ anymore – not that it should have ever been that – but ‘Have they tanked yet?'” said the custodian sales head.

He added: “Investors have to be concerned – if it has happened to Jamie Dimon’s JP Morgan, which came out of the crisis relatively unscathed, it can happen to anyone.”

Over the past five years, several banks around the world have suffered losses due to lapses of internal control. French bank Société Générale was hit by a trader trying to beat the system, followed by a similar case at Swiss bank UBS last year.

JP Morgan’s losses were incurred in a department that did not manage client money, the bank said, but this is merely a technicality for some.

The Head of Trading at a London-based asset manager said although the details around what had happened were yet to be fully revealed, market participants believed the errors were ‘scalable’ so the problem could have been a lot worse should markets have moved more dramatically.

He said: “Just imagine we’d woken up last week to the news that JP Morgan hadn’t lost $2 billion, but $30 billion, or even more. A bank that size can absorb $2 billion, but if the loss had been worse, think of the carnage then. It’s unlikely any government would want to bail them out.”

A senior investment consultant said this latest investment banking disaster would speed up the debate on collateral and central clearing of over-the-counter derivatives, adding that it strengthened the argument for clearing houses and intraday collateral, to help better insulate investors from potential losses.

JP Morgan boss Dimon is to face a shareholder vote today, demanding his role of Chairman and Chief Executive Officer be split between two people.

The darlings of institutional investors last year, commodities and emerging market stocks have fallen from grace this year as economic turmoil continues to wreak havoc on markets.

(May 11, 2012) — Confidence in returns from commodities has seen a sharp downturn in the past year and fears emerging markets might be overheating have dominated investors’ decisions, research has shown.

Commodities fell from the asset class thought to be the most likely to outperform last year, voted for by investors responding to a survey conducted by the Economist Intelligence Unit (EIU), to third place this year. In percentage terms, support fell from over a quarter of investors believing commodities would shoot the lights out last year to just 14% this year.

The research body said ‘the notable turnaround’ reflected “lower demand for many raw materials from sluggish developed markets in the Eurozone and elsewhere”.

Emerging market equities – which tied with commodities for the top spot last year – were also toppled as investors turned fearful over their short term prospects. Equities listed in the investors’ specific home country sat at the top of this projected performance table, with 26% of the vote.

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These views covered just the next 12 months though, and in the long term, investors are still bullish on emerging markets, the EIU revealed.

However, which emerging markets favoured by investors has changed. Brazil suffered the greatest fall in confidence this year, followed by China and India. These three had been the most popular choices last year; this year, Brazil has fallen behind South East Asia – which saw the largest improvement in investor confidence – and northern neighbour the United States.

Tellingly, some 57% of investors reported feeling concerned that some emerging markets were overheating, but there was still strong potential for growth. Only 10% said they thought these nations were nearing their peak in value.

The research was conducted in January this year, surveying nearly 800 institutional investors in 77 countries and was launched at the Bellwether Europe conference held in London yesterday.