JPMorgan’s $200 Million Dollar “Unfortunate” Derivatives Contract

Past performance is not indicative of future results. This brief disclaimer shows itself everywhere securities are sold. This is not even in fine print. The real fine print along with endless contractual pages are barely read by investors. Often times, contracts that are less than transparent, such as derivatives contracts, can be misunderstood by parties entering into those contracts.

The responsibility is on the person entering into the contract to read and understand the nuances of that contract. In the case of JP Morgan Chase & Co, and BVG, Berlin’s public transport provider, the Berliner Verkehrsbetriebe has found itself in a $200 million dollar loss. Bloomberg notes that JPMorgan comments “BVG has only itself to blame for signing an unfortunate derivatives contract” that ended up in $200 million in losses. But the financial giant notes that things could have gotten worse, as the loss “coincided with the start of the global financial crisis.” JPMorgan noted that BVG looked for a scapegoat rather than to face the simple truth that their bet went sour. Finally, JP Morgan had to sue the transportation company to try to get some of its money owed back- with interest.

Bloomberg notes that JPMorgan’s staff is accused of “shutting their eyes” when BVG did not understand the complexity of the credit derivative contracts. But to be fair, there are very few PhDs and quants who can actually tell you every detail of derivatives from alpha, beta, delta and gamma. The contracts tend to be quite complex as credit swaps and derivative trenches grow in size in a portfolio. Inherently, the bet is low in risk, because the risk is spread over quite a few consumers. However the tail risk cannot be downplayed- and in the case of a black swan, as what happened in the defaults and crisis, the markets were in turmoil.

BVG feels that without experience in this area, they were mislead by JPMorgan. They believe that JPMorgan downplayed the risks and did not fairly represent those tail risks. They also feel that Clifford Chance , the lawyers who advised them and who also advised JPMorgan regarding the contracts, had a conflict of interest. At this time, BVG is trying to have its case heard in Germany, on home turf. JPMorgan for three years attempted to get this case heard in the UK. Justices from the EU in 2011 ruled that JPMorgan can have its case heard in Britain. At this time the trials are expected to last approximately two and a half months.

Image Credit: JPMorgan Access.com