By Christopher Whittall
LONDON, April 10 (IFR) - Senior credit traders believe hedge funds are trying to squeeze positions held by renowned JP Morgan trader Bruno Iksil by leaking details of his purported positions to the press.
Stories broke late last week that Iksil’s positions were creating distortions in credit markets, with a range of hedge funds and banks cited as sources.
One buy-sider said that the tale was nothing more than rampant speculation and dismissed the idea that the trader may have broken some of the indices, given the many factors affecting synthetic and broader markets such as troubled sovereigns, banks, and low liquidity.
Some traders attributed the press leaks to an attempt to squeeze and profit from a move in the market by firms that had taken the other side of his trades, which were causing them a lot of pain.
“The market is very illiquid in general and people have very much reduced risk limits - this creates weird price actions. This sounds like a bunch of disgruntled hedge funds trying to take advantage of the poor liquidity in the market and force him to cut his positions,” said a senior trader at a major bank.
Iksil, who works in JP Morgan’s London office, was reported to be long the Series 9 of the Markit CDX North America Investment Grade index (CDX.IG.NA.9), with a Bloomberg report suggesting he had built up a $100bn position in the index.
Iksil is well-known and respected in the market in his role in JP Morgan’s Chief Investment Office, which manages macro risks across the whole of the bank’s operations. The CIO often uses credit instruments to hedge tail-risk scenarios across the bank’s books.
If the CIO’s position is a hedge, it seems unlikely that it will be forced to exit.
Meanwhile, hedge funds could have been badly burnt if they took a short position on the Series 9 contract that Iksil is reportedly long.
The five-year contract more than halved from its high of 166.85bp last October to a low of 63.49bp in March, and is due to expire in December this year. The index has since rallied slightly to 78.97bp at close yesterday.
The Series 9 stands apart from other “off-the-run” indices not least because it was used to hedge synthetic CDOs and tranches, but also it had four names - Fannie, Freddie, CIT Group and Washington Mutual - that all eventually defaulted.
It was the last index which had an active tranche market and commenced trading as the “on-the-run” on September 21, 2007 rolling six months later.
CIO‘S DEEP POCKETS
JP Morgan’s CIO is focused “on hedging aggregate structural risks and investing to bring our assets and liabilities into better risk alignment. They are not focused on short-term profits,” JP Morgan spokesperson Joe Evangelisti wrote in an email.
JP Morgan’s Treasury and CIO has a combined investment portfolio of $356bn as of end of 2011 (around 16% of the firm’s total assets) to hedge the bank’s company-wide risk such as changes in interest rates, foreign exchange and credit risk.
Some observers have cast doubt on the likelihood of one trader amassing a net CDS position in Series 9 which is greater than the combined derivative holdings of all except six banks. They also point out a $100bn gross notional would be quite appropriate to hedge JP Morgan’s credit risk exposure or its liquid asset portfolio for risk management purposes.
“We have a lot of high grade credit as we lend to blue-chip companies, so we buy credit derivatives in the case those credits deteriorate. [In this case] we had a big hedge against credit deteriorations and then had to take some off that off,” said one source at the bank.
JP Morgan’s CIO- and Iksil in particular - is renowned in the market for taking large positions. Many attribute this to the size of JP Morgan’s banking franchise and the consequent size of risks it has to hedge, with a balance sheet of around $2.3trn.
Even without factoring in offsetting losses elsewhere in the bank, profits in the CIO business division where traders including Iksil work, delivered in 2011 only $411 million of JP Morgan’s $19 billion of net income, or about two percent, according to the company’s financial disclosures.
In 2010, the business showed profit of $670 million, or about 4 percent, of $17.4 billion of net income. In 2009, a year of exceptional turbulence in financial assets, the unit showed profits of $3.1 billion, one-fourth of reported net income.
JP MORGAN‘S BLACK BOX?
There remains an air of mystery around Iksil and the CIO due to its sprawling nature and the size of positions it takes. Dealers are reluctant to discuss Iksil’s activity openly as he is a client, but they reject the notion that he is running large outright positions.
“The CIO is a massive black box and he’s is a very big trader, but that’s because JP Morgan is massive house and he’s managing the overall risk,” said the senior trader at a major bank.
“It can easily be misconstrued what the JPM CIO actually does and spun much worse than it actually is,” added one head of European credit trading at a major bank.
The remuneration policy of the CIO also undermines the theory that it takes outright punts on the market. Traders are understood to be evaluated and paid on how closely they deliver the assigned offsets to positions elsewhere in the bank.
In other words, as long as trades hedge as intended, the trader would get paid the same amount if the positions lost $100 million as if they made $100 million.
Many other banks are also understood to have comparable functions to JPM’s CIO. The French banks, Citigroup, Deutsche Bank and UBS were all cited as examples of large treasury functions that hedge credit exposures across their institutions in similar ways.
“JP Morgan is a big company and therefore through their CIO they would have to take significant positions, but nothing that would be qualified as abnormal,” said one global head of credit trading at a major bank.