tag:theconversation.com,2011:/ca/topics/jp-morgan-1705/articlesJP Morgan – The Conversation2020-01-06T11:41:34Ztag:theconversation.com,2011:article/1291012020-01-06T11:41:34Z2020-01-06T11:41:34ZBitcoin’s threat to the global financial system is probably at an end<figure><img src="https://images.theconversation.com/files/308427/original/file-20200103-11909-1gq8toc.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">No ifs or bits. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/gold-bitcoin-falling-apart-graph-crashing-1038671149">ImageFlow</a></span></figcaption></figure><p>2020 could well be the year that the cryptocurrency dream dies. This is not to say that cryptocurrencies will die altogether – far from it. But to all the financial romantics who have cheered the rise of bitcoin and other digital currencies over the past decade, there is a reckoning coming. Like it or not, the vision of a world in which these currencies liberate money from the clutches of central banks and other corporate giants is fading rapidly. </p>
<p>It is not that these currencies have no place in the future of money. The encrypted blockchain technology that underpins them is extremely difficult for governments to control, so it is unlikely that they will ever be eliminated. In any case, they have a valid role to play as a geopolitical hedge – witness <a href="https://u.today/bitcoin-price-jumps-five-percent-as-trump-strike-escalates-us-iran-tensions">the surge</a> in bitcoin and cryptocurrencies after the latest escalation in tensions between the US and Iran, for instance. </p>
<p>But 11 years on from bitcoin’s <a href="https://www.theguardian.com/books/2019/jun/26/the-white-paper-satoshi-nakamoto-review">remarkable beginnings</a>, cryptocurrencies are a long way from supplanting the financial system. At the time of writing, the <a href="https://www.coingecko.com/en">total value of</a> all the bitcoin in circulation is US$133 billion (£102 billion); in comparison, the market value of all the world’s gold is <a href="https://news.bitcoin.com/when-bitcoin-overtakes-gold-how-high-can-it-go/">around US$8 trillion</a>, while the total worth of mainstream currencies worldwide is roughly the <a href="https://money.visualcapitalist.com/worlds-money-markets-one-visualization-2017/">same again</a>. </p>
<h2>No new hope</h2>
<p>The so-called bitcoin maximalists foresee a day when their currency of choice rises into the top league. They point to the <a href="https://www.ig.com/uk/bitcoin-btc/bitcoin-halving">bitcoin “halvening”</a> expected in May – the moment every four years when the number of new coins being added to the network is halved – as the next event that will drive prices up. </p>
<p>Yet the long-term prospect for bitcoin and other cryptocurrencies is stasis on the peripheries of the financial system. The chances of a new bitcoin look increasingly slim: it’s several years since ethereum rose to become the prime challenger, before falling back to a fraction of the bitcoin price (click on the chart below to make it bigger). </p>
<p><strong>Bitcoin vs altcoins</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=293&fit=crop&dpr=1 600w, https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=293&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=293&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=368&fit=crop&dpr=1 754w, https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=368&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/308429/original/file-20200103-11919-1u0a2lu.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=368&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Share of total market cap of crypto by coin.</span>
<span class="attribution"><a class="source" href="https://coinmarketcap.com/charts/">Coin Market Cap</a></span>
</figcaption>
</figure>
<p>More importantly, a much bigger threat to the current system is afoot – as evidenced by <a href="https://theconversation.com/facebooks-libra-cryptocurrency-can-still-take-off-and-revolutionise-money-125504">Facebook’s attempts</a> to get its libra digital currency off the ground. JP Morgan has <a href="https://www.bbc.co.uk/news/business-47240760">already launched</a> a JPM coin for <a href="https://cointelegraph.com/news/jpmorgan-will-pilot-jpm-coin-stablecoin-by-end-of-2019-report">major institutional clients</a>, while numerous other major banks are <a href="https://www.ft.com/content/9fd8e8ea-83e5-11e9-b592-5fe435b57a3b">set to</a> follow suit. Other tech giants like <a href="https://articles2.marketrealist.com/2019/08/is-amazon-moving-into-cryptocurrency/#aprd">Amazon</a>, <a href="https://cointelegraph.com/news/google-coin-within-2-years-as-fangs-will-go-crypto-say-winklevoss">Google</a> and <a href="https://www.computerworld.com/article/3435851/apple-exec-confirms-cryptocurrency-is-on-company-radar.html">Apple</a> are rumoured to be looking at launching rival currencies as well. </p>
<p>Their model is what are known as stablecoins – a sort of crypto hybrid that lives on blockchains but is pegged to mainstream currencies. But aside from this connection to the status quo, these multinationals would be challenging sovereign money. They want to opt out of the clunky system that they have been forced to operate in, <a href="https://theconversation.com/blockchains-first-revolutionary-product-could-be-online-id-128028">with its</a> transaction fees and international payment delays, to present customers with an alluring alternative instead. </p>
<p>The reason these companies are not throwing their weight behind bitcoin et al is because today’s cryptocurrencies have <a href="https://theconversation.com/blockchains-first-revolutionary-product-could-be-online-id-128028">at least as many</a> drawbacks as the mainstream system. Their prices are too volatile to act as a serious store of value, for instance, while their ability to process financial transactions is not yet particularly impressive. </p>
<p>It has dawned on the corporate giants that as per their products or services, they can make money part of their brand – part of the customer experience. Sell people goods and services, yes, but also offer them a new monetary system to take care of the purchases. It begins to look like almost total control. </p>
<h2>The empire strikes back</h2>
<p>The state has been late to wake up to this challenge, but has now done so in a powerful and surprising way. The traditional global infrastructure has proved strong enough to <a href="https://www.pymnts.com/cryptocurrency/2019/global-bankers-meet-with-fb-jpm-on-stablecoins/">derail</a> the corporates at least temporarily <a href="https://www.cnbc.com/2019/11/21/new-bill-would-make-facebooks-cryptocurrency-a-security-under-the-law.html">with</a> <a href="https://www.euractiv.com/section/economy-jobs/news/commission-wary-of-side-effects-of-libra-regulation/">red tape</a>. Yet make no mistake – the goalposts have completely changed, and it will be difficult to present a united regulatory front around the world. Ironically, it is the same lack of global uniform regulatory approval for the existing cryptocurrencies that has hindered their meaningful adoption. </p>
<p>The other response under examination is to launch state cryptocurrencies. <a href="https://theconversation.com/when-china-and-other-big-countries-launch-cryptocurrencies-it-will-kick-off-a-global-revolution-128678">The likes of</a> China and Russia are in pole position to launch the first within a couple of years. Deutsche Bank <a href="https://www.dbresearch.com/PROD/RPS_EN-PROD/PROD0000000000503196/Imagine_2030.pdf">recently</a> published a report <a href="https://cointelegraph.com/news/deutsche-bank-research-crypto-to-replace-fiat-currencies-by-2030">suggesting that</a> cryptocurrencies could overtake national fiat currencies within ten years, envisaging that these state-backed versions will lead the charge. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=402&fit=crop&dpr=1 600w, https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=402&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=402&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=506&fit=crop&dpr=1 754w, https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=506&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/308430/original/file-20200103-11939-10v0hkf.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=506&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Yuan 2.0.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/china-map-silhouette-symbols-chinese-yen-1543942793">KachuraOleg</a></span>
</figcaption>
</figure>
<p>In short, the future of cryptocurrency lies in either corporate or sovereign digital coins – or more likely, an uneasy cohabitation of the two. The system supposedly under threat from bitcoin and the other so-called bank killers is instead assimilating them. The coins that emerge <a href="https://thenextweb.com/hardfork/2019/09/02/european-central-bank-bigwig-outlines-why-facebooks-libra-isnt-real-cryptocurrency/">maybe</a> won’t <a href="https://ftalphaville.ft.com/2019/06/18/1560849057000/Facebook-s-Libra--blockchain--but-without-the-blocks-or-chain/">even use</a> blockchains, acting more akin to Paypal or WeChat Pay than as cryptocurrencies as we know them. </p>
<p>Where the previous half century saw the rise of corporates to a size and influence comparable to nation states, the next half century could produce a new paradigm in which they increasingly behave like nation states. When we reflect on the way these companies already manage our data, the way they exert lobbying influence on our governments, the trend is clearly well underway. Call it the next phase of globalisation. </p>
<p>Money in 2030 will probably therefore be almost unrecognisable compared to what we use today. The dream of universal people-powered monetary substitutes is being crushed by this unanticipated but in hindsight inevitable institutionalisation. It is from within the multinational world that the “next bitcoin” will emerge – wrapped in the liveries of a corporate brand, if not a sovereign flag. As for the great dream of bitcoin liberation, may it rest in peace.</p><img src="https://counter.theconversation.com/content/129101/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gavin Brown is a non-executive director and co-founder of Winterbar Associates Limited, a start-up digital assets fund which has yet to launch. It would not benefit directly from this article but does have an interest in digital asset investments such as bitcoin which leverage blockchain technology.</span></em></p><p class="fine-print"><em><span>Whilst Richard Whittle has received no direct funding for this article, the background research was conducted as part of his ESRC-funded PhD.</span></em></p>Will 2020 be the year that the new threat to fiat currencies reaches maturity?Gavin Brown, Senior Lecturer, Finance, Manchester Metropolitan UniversityRichard Whittle, Research Fellow in Economics, Manchester Metropolitan UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/884402017-12-05T12:04:56Z2017-12-05T12:04:56ZBitcoin is a highly speculative investment. Why caution is required<figure><img src="https://images.theconversation.com/files/197762/original/file-20171205-22962-14ls1wu.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>With the price of a bitcoin <a href="https://www.coindesk.com/price/">reaching</a> record highs of more than $10,000, more and more ordinary people consider investing in the cryptocurrency. The recent price surge, however, comes with tremendous risks. Investors should be prepared for the possibility that they could lose their entire investment. </p>
<p>Bitcoin <a href="https://www.ft.com/content/c84caffc-d683-11e7-a303-9060cb1e5f44">was launched </a> in 2008 by an anonymous author under the name of Satoshi Nakamoto as a means of transacting among participants without the need for intermediaries. Since the beginning of this year, the price of bitcoin has increased by 1300% as more and more consumers flock to it hoping to profit off its increasing popularity and the associated increase in value.</p>
<p>Cryptocurrencies are not currencies at all. As the Financial Times <a href="https://www.ft.com/content/c84caffc-d683-11e7-a303-9060cb1e5f44">explains</a>, bitcoin is a string of computer codes which means that new bitcons can be created – up to an agreed limit – by computers that gain the right to do so by solving complex puzzles. Transactions are recorded in a database called a blockchain.</p>
<p>Bitcoin, like other assets like gold, doesn’t yield income. You have to sell it to realise any value. And, like gold and other currencies, it can be transferred peer-to-peer.</p>
<p>Part of the nervousness about bitcoin is that, along with other cyptocurrencies, it challenges the traditional role of banks and central banks. In the classical world, banks act as intermediaries by providing loans out of the deposits they took and from funding from the central bank. The central bank uses the rate at which it provides this funding as a lever to ensure price stability. The introduction of cryptocurrencies threatens this model because banks are no longer necessary to intermediate funds and there is no central bank to ensure that prices are stable.</p>
<p>The more immediate fears about bitcoin centre on the recent dramatic rise in its value. There’s nervousness in the market that a <a href="https://www.cryptocoinsnews.com/bitcoin-price-flash-crashes-10075-market-goes-berserk/">flash crash</a> might be imminent after the cryptocurrency tumble by more than $1,300 in minutes on the bitcoin exchange <a href="https://www.bitfinex.com/">Bitfinex</a>. It did recover to levels above $10,800.</p>
<p>The flash crash echoes long standing warnings that the bitcoin party is set to end in tears. Most recently Jamie Dimon, CEO of JPMorgan, one of the world’s largest investment banks <a href="https://www.bloomberg.com/news/articles/2017-09-12/jpmorgan-s-ceo-says-he-d-fire-traders-who-bet-on-fraud-bitcoin">declared</a> that he would fire any employee trading bitcoin for being stupid.</p>
<p>In a highly unusual alliance, his words were echoed by economics Nobel Laureate Joseph Stiglitz, who has gone even further <a href="https://www.bloomberg.com/news/videos/2017-11-29/joseph-stiglitz-bitcoin-ought-to-be-outlawed-video">arguing</a> that bitcoin:</p>
<blockquote>
<p>ought to be outlawed. </p>
</blockquote>
<p>All of these are clear warning signs that the professionals do not trust the lofty <a href="http://bitcoinaccrual.com/bitcoin-after-2000-years-something-fundamentally-different/">promises</a> of crypto enthusiasts. </p>
<h2>The blockchain factor</h2>
<p>There is no doubt that Bitcoin – and in particular blockchain, the technology behind it – has the potential to revolutionise the financial services industry. </p>
<p>A blockchain functions as a transparent and incorruptible digital ledger of economic transactions, recorded in chronological order, that operates on a peer-to-peer network. </p>
<p>Fundamentally, the technology allows exchange of value to occur in an environment of peers with conflicting interests without the need for trusted intermediaries. That, in effect, wipes out the need for banks or financial services companies which fulfil this role.</p>
<p>The use of the technology is not limited to financial transactions. Virtually anything of value can be traded on a blockchain.</p>
<p>But no matter how useful the underlying blockchain technology is, or how widely it can be applied, there are real and substantial risks involved in bitcoin. </p>
<h2>Volatility versus returns</h2>
<p>The first, and most significant risk is that compared to any currency, share, or gold, bitcoin is extremely volatile. The volatility of bitcoin to US dollar is almost six times the volatility of the Rand to US dollar. While this is great in good times, it is potentially devastating for investors in bad times. </p>
<p>When professional investors decide on which assets to hold, they look at both the return and the volatility of the asset. Only investors with a healthy appetite for risk are willing to invest in risky, volatile assets. Usually these are finance professionals, for example in large investment banks or hedge funds. </p>
<p>Investors with a lower risk appetite, such as asset managers or pension funds, prefer assets with a somewhat lower return, but which are less volatile. </p>
<p>The rule of thumb is that the sophistication of an investor increases with the volatility of the asset she invests in. But with bitcoin this rule of thumb doesn’t hold true. More and more private investors have been <a href="https://www.cnbc.com/2017/11/27/bitcoin-exchange-coinbase-has-more-users-than-stock-brokerage-schwab.html">flocking</a> to bitcoin ‘exchanges’ that have sprung up all over the internet and that are aggressively advertised on social media.</p>
<h2>Overvalued</h2>
<p>There is a huge risk that bitcoin is already overvalued. </p>
<p>The practical use cases for bitcoin are limited. It doesn’t enable enough transactions to take place per second to be used as a replacement for a modern payment system. And it doesn’t offer any functionality other than pseudonymous transactions – transactions where the true identity of the counterparties is hidden.</p>
<p>Bitcoin is <a href="http://bitcoinafrica.io/2017/11/09/pyramid-scheme-mmm-nigeria/">favoured by pyramid schemes</a>, including the infamous MMM pyramid scheme in Nigeria. In a <a href="https://www.ft.com/content/1877c388-8797-11e5-90de-f44762bf9896">recent article</a>, the Financial Times called bitcoin itself a pyramid scheme, much to the <a href="http://www.newsbtc.com/2017/01/04/financial-times-bitcoin-is-a-pyramid-scheme/">dismay</a> of crypto enthusiasts. (<a href="https://www.merriam-webster.com/dictionary/pyramid%20scheme">A pyramid scheme</a> is usually an illegal operation in which participants pay to join and profit mainly from payments made by subsequent participants. If no new people come in, it collapses.)</p>
<h2>Regulatory risk</h2>
<p>The third, and possibly biggest risk is regulatory. In September 2017, the Chinese government <a href="https://www.forbes.com/sites/kenrapoza/2017/10/18/chinas-blockchain-bitcoin-ban-no-match-for-stateless-cryptocurrency-market/#99bce232de6b">outlawed</a> bitcoin exchanges in mainland China, sending the price of bitcoin tumbling. </p>
<p>Despite the claim that bitcoin is a “global currency”, the reality is that 58% of all bitcoin mining <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2965436">happens in China</a>. If at any point the Chinese government should decide to make Bitcoin mining illegal the price is likely to plunge into oblivion. </p>
<p>Other countries have also voiced concern. The Russian Central Bank recently <a href="https://www.coindesk.com/russian-central-bank-issues-new-warning-against-cryptocurrencies/">issued a warning</a> to investors on the risks of investing in cryptocurrencies, citing concerns about a bubble. This suggests that there might be a concerted crackdown.</p>
<p>Cryptocurrencies are <a href="https://www.bloomberg.com/news/articles/2017-11-26/what-the-world-s-central-banks-are-saying-about-cryptocurrencies">banned</a> in India as their use is a violation of foreign exchange rules. The Australian Reserve Bank has taken a <a href="http://www.rba.gov.au/speeches/2017/sp-so-2017-10-27.html">different approach</a>. It monitors the cryptocurrency market in a bid understand the underlying technology.</p>
<p>The South African Reserve Bank has <a href="https://www.cryptocoinsnews.com/south-african-central-bank-open-cryptocurrencies-blockchain-tech/">expressed</a> its openness to blockchain technologies. But it has also <a href="https://www.resbank.co.za/RegulationAndSupervision/NationalPaymentSystem(NPS)/Legal/Documents/Position%20Paper/Virtual%20Currencies%20Position%20Paper%20%20Final_02of2014.pdf">highlighted</a> potential risks to consumers.</p>
<h2>A classic bubble</h2>
<p>There are real risks that many consumers investing in cryptocurrency don’t fully understand. Advertisements promise that bitcoin can make you rich fast. And social media is alive with stories about friends of neighbours or distant cousins who have made a lot of money through bitcoin. </p>
<p>Without a doubt, these cases are real, and those who invested early can reap large benefits. But this is true in every bubble – from the dotcom bubble to the tulip mania. It’s also true in every pyramid scheme.</p>
<p>As always, investors should be extremely wary with any scheme that promises quick returns.</p><img src="https://counter.theconversation.com/content/88440/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The astronomic rise of the price of bitcoin over the past 12 months raises fears that the cryptocurrency is set to crash which could see many people lose money.Co-Pierre Georg, Senior Lecturer, African Institute for Financial Markets and Risk Management and Director, UCT Financial Innovation Lab, University of Cape TownQobolwakhe Dube, PhD candidate, University of Cape TownLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/176082013-09-02T05:39:15Z2013-09-02T05:39:15Z‘Window dressing’ will not restore JPMorgan’s image<figure><img src="https://images.theconversation.com/files/30383/original/5vvkz4tk-1377880138.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Sailing through troubled waters.</span> <span class="attribution"><span class="source">Chris Ison/PA</span></span></figcaption></figure><p>Another week, another banking scandal. In the past few years we have seen what appears to be an endless line-up of banks behaving badly. They have engaged in rate manipulation, <a href="https://theconversation.com/a-whale-of-a-time-how-traders-cost-jp-morgan-billions-17130">rogue trading</a>, product mis-selling and some have even died – leaving the taxpayer to pick up the bill. </p>
<p>Last week, it was JPMorgan’s turn on the naughty step. The elite North American investment bank has faced a <a href="http://www.ft.com/cms/s/0/ee9e943e-0f33-11e3-ae66-00144feabdc0.html#axzz2dQz9G0ra">raft of allegations</a> including nepotistic employment practices in China, miscategorising investments in a wealthy client’s portfolio, selling questionable mortgage backed securities to US government agencies and manipulating the US energy market.</p>
<p>Such claims could cost JPMorgan dearly. At the start of the week, a New York judge requested the bank to pay $42.3m plus interest to a <a href="http://www.bbc.co.uk/news/business-23845347">Russian billionaire</a>. This is small change when compared to the $6 billion that the US Federal housing agency are demanding the bank pays to settle allegations it mis-sold mortgage backed securities in the <a href="http://www.ft.com/cms/s/0/423ba922-0f27-11e3-ae66-00144feabdc0.html?siteedition=intl#axzz2dQz9G0ra">run-up to the financial crisis</a>. When put together, all these legal headaches are a significant cost. </p>
<p>The mounting legal fees could be seen as an annoying cost of doing business. But the real price of all these legal challenges and the associated media furor that comes with them are to the legitimacy of the bank. A loss of legitimacy for a business can have significant consequences: higher capital costs, demotivated employees, increased regulations, negative media attention and wary customers.</p>
<h2>Going legit</h2>
<p>If declining legitimacy is a real problem for the large banks, then how can they try to win it back? Window dressing is always a huge temptation, but the big problem is that saying you have changed is often quite different from actually making the change. There are many cases where businesses announce a big change that is supposed to make them more responsible. They get the glory, but they don’t do the follow through. </p>
<p>For instance, some pharmaceutical firms which were under pressure from activists to provide cheap HIV medication in developing countries announced they were going to drop their prices, but did not do anything for <a href="http://bas.sagepub.com/content/45/2/178.short">quite some time</a>. This is a kind of <a href="http://didattica.unibocconi.eu/mypage/upload/48908_20111102_031549_BRUNSSON_1986.PDF">organised hypocrisy</a> whereby organisations maintain a distance between what they say and what this do. Hypocrisy has the advantage of helping an organisation comply with the demands of external stakeholders at the same time as the core operational processes are left untouched.</p>
<p>Window dressing is certainly one tactic a bank might pursue. They could publicly admit they were wrong, say “things are going to change around here”, and announce a few high-profile programmes designed to clean up operations. </p>
<p>But at the same time, it is also possible to “<a href="http://www.patriciabromley.com/BromleyPowellDecoupling.pdf">de-couple</a>” these changes from the everyday working practices and routines in the bank. This means that the banks will not have to engage in the difficult, costly and often painful process of changing the work routines. This would be tantamount to reminding bankers that appearing to be good is important, but it should not be taken too seriously.</p>
<h2>Dangerous dressing</h2>
<p>Although window dressing is very tempting, recent research has suggested it can also be dangerous. A study of an unnamed US financial organisation following a scandal triggered by deceptive sales practices show <a href="http://amj.aom.org/content/53/6/1499.abstract">how these dangers work</a>.</p>
<p>When faced with a scandal, the organisation initially developed a façade that looked good from the outside, but was detached from the day-to-day sales practices within the firm. This created a rift between what external stakeholders thought the firm was doing and what people within the firm were actually doing. People within the firm felt like pressure was off and went on with their old ways, and mis-selling became even more widespread. </p>
<p>Gradually this came to the attention of regulators and others. It destroyed the fragile sense of legitimacy the firm had been able to rebuild following the scandal, and it once again became a pariah in its industry. The lesson here is that window dressing might help a firm rebuild legitimacy in the short term, but it creates the conditions for unethical practices to thrive beneath the surface, which will undermine the legitimacy of the firm in the longer term.</p>
<h2>What’s a bank to do?</h2>
<p>This has some important implications for large banks like JPMorgan. They may be tempted to take a financial hit on the legal cases, say they were wrong in public, and then do some ethical window dressing. But this may simply create the conditions for unethical practices to thrive behind the nice façade, leading to yet more scandals. </p>
<p>If the bank hopes to rebuild its legitimacy over the longer term, it needs to ensure there is a tighter connection between their public pronouncements and the practices behind the scenes. Doing this does not just involve restructuring, a new set of values or a few training courses. It involves deeper changes to the day-to-day routines, business practices and culture.</p>
<p>There are some constructive steps which large banks can take. The first is that when new compliance or ethics programmes are introduced into a firm, it is vital to highlight these are not being done for cynical reasons (such as avoiding legal issues).</p>
<p>Second, it is important that the values a firm connects with its compliance and risk management activities resonate with the personal and professional values of people within the firm. Many people working in knowledge intensive organisations like banks feel their <a href="http://hum.sagepub.com/content/62/3/353.abstract">work is utterly disconnected from their values</a> outside the workplace. Organisational pressures have often clashed with professional commitments and there is a real opportunities to recreate some alignment here. </p>
<p>Finally, new measures designed to get rid of unethical activities must be built into the everyday work processes in an organisation. The large banks have already taken some steps in this direction. But it is really a matter of ensuring that this becomes part of the core work processes, not just pesky internal policing which holds back deal-making.</p>
<p>Winning back public trust in the banking sector will not be an easy task, but it is a vital challenge both for JPMorgan and across the whole sector. If attempts to change really are revealed as mere “window dressing”, the next time a big scandal hits the public are likely to be far less understanding.</p><img src="https://counter.theconversation.com/content/17608/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andre Spicer does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Another week, another banking scandal. In the past few years we have seen what appears to be an endless line-up of banks behaving badly. They have engaged in rate manipulation, rogue trading, product mis-selling…Andre Spicer, Professor of Organisational Behaviour, Cass Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/171302013-08-21T05:19:08Z2013-08-21T05:19:08ZA whale of a time: how traders cost JP Morgan billions<figure><img src="https://images.theconversation.com/files/29545/original/dhmqwm77-1376926050.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">That's one expensive cetacean.</span> <span class="attribution"><span class="source">wwfunitedkingdom</span></span></figcaption></figure><p>As long as there have been financial markets, there have been serious financial losses. But the traders of today have shown a talent for blowing billions. </p>
<p>During the most recent round of financial misadventures, we have seen <a href="http://www.nytimes.com/2010/10/06/business/global/06bank.html?partner=rss&emc=rss">Jérome Kerviel</a> lose Société Générale €4.9 billion and <a href="http://www.theguardian.com/business/2013/aug/01/kweku-adoboli-fraud-appeal-ubs">Kweku Adoboli</a> lose UBS $2 billion. </p>
<p>Now the attention of financial commentators and astounded public is on the management of the so-called “<a href="http://www.bbc.co.uk/news/business-23692109">London Whale</a>” trading losses – revolving around a trader in financial derivatives working at JP Morgan’s London office called Bruno Iksil. This time the loss is a whopping $6.2 billion. </p>
<p>In the past few days, the lid has been lifted on the inner workings of the world of trading by a legal case filed in New York. The London Whale himself has not been charged with any wrongdoing, and has co-operated with authorities throughout their investigation. Rather, the case has been brought against two of his managers – Javier Martin-Artajo and Julien Grout.</p>
<p>The papers allege these two individuals were responsible for hiding more than $660m in losses associated with the case. A careful reading of two <a href="http://www.scribd.com/collections/4324650/JPMorgan-London-Whale-Case">16-page documents</a> reveals some of the dynamics that allowed the company to lose so much in such a short period of time, and not be picked up.</p>
<h2>What went wrong</h2>
<p>The first thing that struck me about this case is just how complicated the day jobs of the people involved were. They traded in <a href="http://www.investopedia.com/terms/c/creditdefaultswap.asp">credit default swaps</a>. These are like an insurance policy on an underlying credit risk. Sounds complicated right? Well imagine trying to manage a huge institution full of people doing equally complicated activities. </p>
<p>Oversight is going to be difficult when the task to oversee is so baroque. This creates significant space for traders to hide mistakes and operate off the regulatory and even managerial radar. <a href="http://hum.sagepub.com/content/54/7/863.short">Research</a> on knowledge workers - those who, like traders, “think for a living” - suggests that the technical complexity of their tasks often creates ambiguity: the right and wrong answers are unclear and difficult to understand. These workers can take advantage of ambiguity to buffer themselves from the prying eyes of would be managers and regulators. This can be good, as it creates autonomy and intellectually challenging work for the professional. But it can be bad insofar as there is a lack of monitoring which can stop potentially disastrous mistakes being made. Such conditions of complexity create the perfect conditions for rogue trading to flourish.</p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=820&fit=crop&dpr=1 600w, https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=820&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=820&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1030&fit=crop&dpr=1 754w, https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1030&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/29546/original/3ktq8kbs-1376926690.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1030&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">It’s a long way down from the heights of JP Morgan.</span>
<span class="attribution"><span class="source"> Koukouvaya*</span></span>
</figcaption>
</figure>
<p>The next big insight to be found in this document is the fact that it was not just one individual engaged in the London Whale trade, but a group of people. The losses were quickly identified and there are several emails in which Iskill tells his superiors that the losses are escalating and he could no longer hide them. But because these things are complex and based on risk, there was hope the loss was recoverable – they just had to wait and the market would change. </p>
<p>According to the court documents, the more senior manager (Martin-Artajo) noted that he was under pressure from New York (the headquarters) to deliver good results. The more junior (Groute) recognised he certainly had some wriggle room in how he kept track of the results every day (the difference between bid and ask price on which the contracts were valued), and he used it to avoid having to report the losses. By doing this, both of the managers were able to look good to HQ, thereby preserving their own prospects and the prospects of their department. </p>
<p>If the prosecution’s version of events is true, why did the group not come clean when it was clear how much money they had lost? <a href="http://link.springer.com/article/10.1007/s10551-007-9551-9#page-1">Research suggests</a> that as soon as we commit to one minor misdemeanour, we are far more likely to commit to a larger related one. So for instance, if I say to my colleague I will go for a beer with them during work hours, then I am more likely to go on to drink many more beers (even though I know it is probably a bad idea). This is what we call escalating commitment. In the London Whale case, we see a perfect case of “escalating deception”, when small deceptions lead to ever-larger ones. </p>
<p>The final big insight from this report is there was little independent checking. The legal document notes that only one person was charged with independently checking the risk of decisions made by traders in this part of the organisation. And given the lack of capacity, this person did not tend to make independent judgements. Instead they relied on the expert of advice of the traders. The result is that the very people who were supposedly being monitored were providing expert advice to the person who was supposed to be checking on them. </p>
<h2>Lessons for industry</h2>
<p>Recent examples of traders making huge losses not only offer some important lessons about what can go wrong, but also what financial institutions may need to fix in the future.</p>
<p>First, it is quite clear that the complexity of the products many traders are dealing with created room for highly specialised experts to exploit the widespread ignorance about what they were up to. Dealing with this might mean cutting back on complex products. Where this is not possible, it might mean trying to contain complexity so failures cannot happen on such a grand scale.</p>
<p>Second, organisations must get over the bias towards reporting good news. To do this, financial institutions need to allow and indeed positively encourage employees to give bad news when they see it. The kind of no-fault reporting of safety issues found in the petro-chemical industry is an example of this. What this means is that if you are an employee and see a problem on an oil-rig and you report it, you will not be held at fault. This often liberates the identification of minor problems and an ethos of continued improvement.</p>
<p>Third, it’s clear rogue trading builds up over time. To stop this, circuit breakers and clear decision points are useful. These force people to periodically stand back and reflect on whether they are making wise choices. An example here is the treadmill which forces a runner to slow down every 30 minutes, thereby potentially saving them from an injury. It is also important to offer people easy ways out when they realise they have got themselves in too deep. </p>
<p>Finally, we saw that rogue trading is often missed because there is a lack of independence in oversight. To address this, it is vital that financial institutions build in better risk management roles that can take genuinely independent views. This has certainly already begun to happen in most large institutions. The really big challenge is to make these internal critics into a daily part of the trading floor who are not treated as impediment to doing business. Doing this involves bringing together a risk loving culture of the traders with a more risk averse culture of the compliance team. It may sound impossible, but it is a daily reality in many other sectors like resource exploration, the military, and emergency services. </p>
<p>And if organisations like JP Morgan don’t start building these measures into their workplace culture, groups of traders are going to keep losing them billions.</p><img src="https://counter.theconversation.com/content/17130/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andre Spicer does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>As long as there have been financial markets, there have been serious financial losses. But the traders of today have shown a talent for blowing billions. During the most recent round of financial misadventures…Andre Spicer, Professor of Organisational Behaviour, Cass Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/69862012-05-11T07:41:07Z2012-05-11T07:41:07ZJP Morgan’s “egregious error” and the case of the known unknowns<figure><img src="https://images.theconversation.com/files/10575/original/kpybjnq5-1336721378.jpg?ixlib=rb-1.1.0&rect=28%2C48%2C2637%2C1800&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">JP Morgan chief Jamie Dimon: trading loss was "an egregious error" that underlines the case for Volcker.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>The content and tone of JP Morgan chief Jamie Dimon’s telephone call to analysts explaining <a href="http://www.sec.gov/Archives/edgar/data/19617/000001961712000213/jpm-2012033110q.htm">JP Morgan Chase’s regulatory filing</a> to the Securities and Exchange Commission reporting a $2 billion loss in derivative trading demonstrates that the true cost to the bank should be measured in ideational and reputational terms. </p>
<p>The trading loss was an “egregious” error, the result of ‘self-inflicted’ mistakes that ‘violate our own standards and principles’ and which “plays right into the hands of a whole bunch of pundits out there,” he conceded. </p>
<p>The reputational damage is magnified by the fact that the losses reflected poor risk management within what the firm terms its Chief Investment Office. Buried within the filing (page 9), <a href="http://www.sec.gov/Archives/edgar/data/19617/000001961712000213/jpm-2012033110q.htm">the firm notes</a> that the “CIO has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed.” </p>
<p>The frank admission of “sloppiness and bad judgement,” and determination that the firm would “admit it, we will learn from it, we will fix it, and we will move on” was an exercise in damage limitation. </p>
<p>It is an exercise that is by no means assured of success. Although by no means itself materially catastrophic for a firm which such formidable reserves, the losses have significantly reduced the authority of the bank to lead the campaign to dilute the proposed ban on proprietary trading. </p>
<p>The <a href="http://www.sec.gov/Archives/edgar/data/19617/000001961712000213/jpm-2012033110q.htm">regulatory filing also notes</a> (ironically on the same page) that JP Morgan:</p>
<p><em>“…expects heightened scrutiny by its regulators of its compliance with new and existing regulations, and expects that regulators will more frequently bring formal enforcement actions for violations of law rather than resolving those violations through informal supervisory processes. While the Firm has made a preliminary assessment of the likely impact of these anticipated changes, the Firm cannot, given the current status of the regulatory and supervisory developments, quantify the possible effects on its business and operations of all of the significant changes that are currently underway.”</em></p>
<p>The immediate impact will be seen in the United States itself through the application of the Volcker Rule, a provision of Dodd-Frank named after the formal chairman of the Federal Reserve who first suggested its implementation.</p>
<p>The provision is designed to prohibit proprietary trading by those institutions covered by an implicit government guarantee. The most vocal critic of both the rule and its application was Jamie Dimon himself, who described it as a misguided attempt to prohibit legitimate market making activity that derived from the thinking of a man who “does not <a href="http://www.clmr.unsw.edu.au/article/compliance/market-conduct-regulation/risks-or-rewards-what-volcker-rule-means-wall-street">understand capital markets</a>.” </p>
<p>The failure of the risk management systems within JP Morgan significantly reduces the authority of its chairman and chief executive to lead the charge for a weakening of external oversight. It also highlights, however, the very real global risks associated with derivative trading.</p>
<p>Very famously, the late Donald Rumsfield noted that strategic defence policy was confined by capacity to deal with <a href="http://www.youtube.com/watch?v=_RpSv3HjpEw">“known knowns, known unknowns and unknown unknowns</a>.” </p>
<p>The Global Financial Crisis has provided evidence of all three dangers. The international architecture designed in the aftermath of the crisis is predicated on the need to significantly expand the degree of disclosure within and and oversight of the OTC derivative market. </p>
<p>In its latest report to the G-20 last November, the Financial Stability noted that the failure to design and implement the requisite legal and regulatory frameworks represented a material risk. </p>
<p>The dangers have been highlighted by the rapid expansion in the value of derivative trading. which has returned to pre-Global Financial Crisis levels. As the senior OECD economist, Adrian Wignall-Blundell put it we are, once more <a href="http://www.clmr.unsw.edu.au/article/compliance/market-conduct-regulation/risks-or-rewards-what-volcker-rule-means-wall-street">“off to the races.”</a> The JP Morgan bet demonstrates that the costs of excessive wagering are very real.</p>
<p>The policy problem is that policy design and implementation is constrained by the pace of reform in the major jurisdictions, most notably the United States itself. Here in Australia, Treasury has begun a second stage of consultation, with private briefings with key stakeholders scheduled to run until 15 June on a consultation paper that provides a framework for the Minister for Financial Services and ASIC to make rules covering the disclosure required. </p>
<p>The JP Morgan fiasco provides a granular case study to inform the debate. It also highlights the need for the discussions themselves to take place in an open environment. Warranted trust necessitates nothing less. </p>
<p><em><strong>Justin writes a column for The Conversation, <a href="https://theconversation.com/jp-morgan-should-there-be-a-trading-halt-on-derivatives-6984">The ethical deal</a> and is director of the <a href="http://www.clmr.unsw.edu.au/">UNSW Centre for Law, Markets and Regulation portal</a>, where this story also appears</strong>.</em></p><img src="https://counter.theconversation.com/content/6986/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin O'Brien receives funding from the Australian Research Council for three grants related to corporate governance, financial regulation and accountable governance. This opinion is simultaneously published on an online portal that maps and tracks regulatory reform in the aftermath of the GFC - <a href="http://www.clmr.unsw.edu.au">www.clmr.unsw.edu.au</a></span></em></p>The content and tone of JP Morgan chief Jamie Dimon’s telephone call to analysts explaining JP Morgan Chase’s regulatory filing to the Securities and Exchange Commission reporting a $2 billion loss in…Justin O'Brien, Professor of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/39332011-10-21T03:58:53Z2011-10-21T03:58:53ZSEC slugs Citigroup $285m; but Wall Street reform nowhere near finished<figure><img src="https://images.theconversation.com/files/4719/original/citgroup2-1319088627.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">citgroup</span> </figcaption></figure><p>The US Securities and Exchange Commission (SEC) has chalked up what appears at first glance to be another high-profile success in <a href="http://www.sec.gov/news/press/2011/2011-214.htm">its prosecution of the strategies used by investment banks</a> to profit from the sale of complex financial products. </p>
<p>Without admitting guilt or liability, investment bank Citigroup has agreed to pay a $285 million fine following a civil fraud case brought by the SEC.</p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=800&fit=crop&dpr=1 600w, https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=800&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=800&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1005&fit=crop&dpr=1 754w, https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1005&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/4669/original/wallst.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1005&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The SEC is pursing Wall Street investment banks.</span>
<span class="attribution"><span class="source">AAP</span></span>
</figcaption>
</figure>
<p>The agency argued that the bank misled those who had invested in a complex derivative deal by simultaneously betting that the transaction would collapse in value through its own proprietary trading platform. </p>
<p>“Securities laws demand that investors receive more care and candour than Citigroup provided to these CDO investors,” said Robert Khuzami, the Director of Enforcement at the SEC. </p>
<h2>Goldman Sachs and JP Morgan</h2>
<p>Earlier this year two other major investment banks settled similar litigation. Goldman Sachs agreed to pay a fine of $554 million. JP Morgan settled its case by paying a fine of $153.6 million.</p>
<p>In both cases, the banks failed to disclose that an outside investor - who was betting against the CDO - had played a key role in choosing the securities offered to investors. </p>
<p>In the Citigroup case, it was the bank itself that had chosen the referent securities. </p>
<p>It outsourced the management of the transaction to a unit of Credit Suisse, which served as the collateral manager, giving the illusion of an arms-length transaction. </p>
<h2>Indication of change?</h2>
<p>It remains an open question whether the management of these cases — or indeed the SEC’s general approach to enforcement — presents evidence of the possibility of substantive change in either the internal governance or external policing of Wall Street. </p>
<figure class="align-left ">
<img alt="" src="https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=696&fit=crop&dpr=1 600w, https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=696&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=696&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=875&fit=crop&dpr=1 754w, https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=875&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/4675/original/blankfein3.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=875&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Goldman Sachs chief Lloyd Blankfein.</span>
<span class="attribution"><span class="source">AAP</span></span>
</figcaption>
</figure>
<p>Although in each case the bank committed to remedial action to improve compliance, in none did the SEC seek to appoint an external monitor.</p>
<h2>Stark contrast </h2>
<p>The decision not to mandate ongoing external review of internal compliance processes is linked to concern about regulatory overreach. </p>
<p>Negotiated prosecutions of this type has come in for criticism about the lack of accountability governing how and why such intrusions are warranted. </p>
<p>In part, however other factors are at play, including greater compliance imposed as a consequence of the passage of the <a href="http://www.opencongress.org/bill/111-h4173/show">Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)</a>.</p>
<p>But the rush to settle may, however, create the illusion of justice. </p>
<p>Each settlement is subject to judicial approval - but this is by no means guaranteed, as illustrated by a recent case relating to a claim that Bank of America misled investors over executive bonus payments within Merrill Lynch. </p>
<p>In that case, the US Federal judge, <a href="http://articles.latimes.com/2010/apr/10/business/la-fi-rakoff10-2010apr10">Jed Rakoff</a>, described the proposed settlement as “a contrivance designed to provide the SEC with the facade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry”. </p>
<p>Judge Rakoff reluctantly signed off, citing judicial restraint. He made no secret of his disdain, describing the settlement as “half-baked justice at best”.</p>
<p>This judicial scepticism plays into a growing belief that the operation of the CDO market — and its corollary, the Credit Default Swap (CDS) — was and remains inherently skewed in favour of those packaging complex financial products. </p>
<p>Institutional investors have long recognised that the protection of legitimate self-interest requires the threat of private enforcement action.</p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/4674/original/creditsuisse.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Credit Suisse is also in the sights of the SEC.</span>
<span class="attribution"><span class="source">AAP</span></span>
</figcaption>
</figure>
<p>Cases filed against Credit Suisse, Merrill Lynch, UBS and Deutsche Bank - whose general counsel for the Americas at the time, <a href="http://www.sec.gov/news/press/2009/2009-31.htm">Robert Khuzami</a>, is now director of enforcement at the SEC - suggest significant ethical shortcomings and potential illegalities in the management of conflicts of interest across the entire industry. </p>
<p>In that respect, the settlement between Citigroup and the SEC changes little. </p>
<p>Without apologising or expressing regret, Citigroup released a statement in which it stated: “we are pleased to put this matter behind us and are focused on contributing to the economic recovery, serving our clients and growing responsibly. </p>
<p>"Since the crisis, we have bolstered our financial strength, overhauled the risk management function, significantly reduced risk on the balance sheet and returned to the basics of banking.”</p>
<p>What constitutes the basics of banking is far from resolved. The core conflict remains the dominance of proprietary trading within operating models. </p>
<h2>Volcker Rule </h2>
<p>The Dodd-Frank Act has mandated limitations in a section known colloquially as the <a href="http://www.investopedia.com/terms/v/volcker-rule.asp#axzz1bIMeELmt">“Volcker Rule”</a> after former Federal Federal Reserve chairman, Paul Volcker.</p>
<p>The Volcker Rule calls for restraints to the capacity of regulated banking entities to engage in <a href="http://www.investopedia.com/terms/p/proprietarytrading.asp#axzz1bIMeELmt">proprietary trading</a> or circumvent these restrictions through investing in private equity and hedge funds. </p>
<p>It calls on the SEC to conduct a study and release proposed rules on how this would operate in practice. </p>
<p>The settlements dovetail with the release of these detailed rules earlier this month. While allowing partial exceptions for market-making purposes, they significantly restrain the banks in circumstances where there is an identifiable conflict of interest or involves high-risk assets or trading strategies. </p>
<p>Moreover, the rules mandate banking entities to create a compliance program that is subject to external supervisory oversight. </p>
<p>The banks have until January 13 to make submissions on the proposed rule. Ongoing litigation would have significantly reduced their bargaining position. </p>
<p>With the SEC cases now closed, the bargaining is likely to intensify. Wall Street reform is nowhere near complete.</p><img src="https://counter.theconversation.com/content/3933/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Justin O'Brien receives funding from the Australian Research Council. One of his grants, 'The Limits of Disclosure: Private Rights, Public Duties and the Search for Accountable Governance' looks at the management of conflicts of interest in the design and distribution of complex financial products.</span></em></p>The US Securities and Exchange Commission (SEC) has chalked up what appears at first glance to be another high-profile success in its prosecution of the strategies used by investment banks to profit from…Justin O'Brien, Professor of Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.