WASHINGTON — The sharp loss at the London office of JPMorgan Chase & Co. has shined a focus not just on the pitfalls of one Wall Street company, but also on talks between U.S. and U.K. regulators about coordinating their response to financial shocks.
The bank's loss — sparked by bets from the trader nicknamed the "London Whale" and estimated at well over $2 billion — is hardly the first high-profile fiasco with a U.K. link for a large U.S. firm. The British operation of American International Group was key to the activities leading to AIG's 2008 bailout, and account transfers at MF Global before its recent bankruptcy appeared to involve a U.K. affiliate.
The Federal Deposit Insurance Corp. has already been in talks with the Bank of England over coordinating resolution regimes, and observers said the FDIC's ability to effectively unwind a globally-significant U.S. institution largely depends on just one partner.
"The place to start in terms of cross-border resolution planning is Great Britain because that's where a high percentage of the foreign activity is located. That already deals with a big part of the problem," said Lawrence White, an economics professor at New York University.
The FDIC, which was always able to resolve collapsing banks, was authorized by the Dodd-Frank Act to clean up failing holding companies and nonbank financial companies deemed by authorities to be systemically important. But a key challenge for the new facility is solving the jurisdictional issues of winding down the foreign activities of Wall Street firms.
"It will be important to work out what authority does the FDIC have to exercise control over assets that are located abroad, and tell foreign creditors, 'No, you can't just come in and grab assets; you have to abide by our process,'" White said.
Yet an analysis of where around the world large U.S. banks are most active — an exercise the FDIC calls "heat-mapping" — shows their interconnectedness is concentrated in just a few countries.
Systemically important institutions "are concentrated in a relatively small number of jurisdictions, particularly the United Kingdom," said acting FDIC Chairman Martin Gruenberg earlier this month as the banking structure conference held by the Federal Reserve Bank of Chicago. "Working with the authorities in the U.K., we have made substantial progress in understanding how possible U.S. resolution structures might be treated under existing U.K. legal and policy frameworks."
Examining on- and off-balance sheet totals for five of the top institutions, officials from the FDIC's new Office of Complex Financial Institutions told an advisory committee in January that, while 97% of the activities of those companies lie in 13 jurisdictions, over 90% of the foreign activity for each of them was in no more than three countries. Over 80% was based in the U.K. alone. (The totals were based on December 2011 reporting.)
"If you deal with U.S.-U.K. coordination, from the U.S. point of view you've done a lot," said Karen Shaw Petrou, managing partner of Federal Financial Analytics Inc.
Not surprisingly, six months before Dodd-Frank officially expanded the FDIC's role in 2010, the agency announced a memorandum of understanding with the Bank of England on cooperation in the resolution of large cross-border banks. Among other things, the nonbinding document designated points of contacts at each regulator for consulting with the other, laid out how they would share information about a troubled or failing firm located in both countries and said the two authorities will review their cooperation annually.
An FDIC spokesman said the FDIC and the Bank of England have made further strides in coordination, but offered little detail beyond that.
"The 2010 MOU provides a sound legal basis for the discussions that we continue to have with the UK authorities," the spokesman said. "We have made major advances in our mutual understanding and mutual planning. Revision of the MOU is not necessary to accomplish that."
In a May 3 speech, Paul Tucker, a deputy governor for the Bank of England, signaled that more details about a common resolution approach between the two countries may be coming.
"Resolution authorities in a number of countries are exploring how to execute 'top-down' resolutions of complex groups, employing bail-in of debt issued by the holding company or top-level operating company," Tucker said. "The US and UK have been working together very constructively in planning how to operationalize that strategy; and if we continue to make progress I hope that we will be able to say more about it over the next few months."
The volume of financial traffic between the two nations has attracted even more discussion from policymakers in recent weeks. One day before JPMorgan Chase announced its trading loss, former Fed Chairman Paul Volcker — testifying before the Senate Banking Committee — made the somewhat foreshadowing remark that "for some of these biggest institutions that have very substantial operations overseas, those operations tend to be centered in the U.K. — so I think you do want to get consistency between the U.K. and U.S. authorities."
Policymakers seem even more interested following the Chase announcement. In a statement announcing plans for a hearing about the bank's trading loss, House Financial Services Committee Chairman Spencer Bachus said one issue for the panel to address is "greater coordination between U.S. and U.K. regulators since many of our largest financial institutions maintain a significant percentage of their overseas holdings in the United Kingdom, and the JPMorgan trades in question were executed from the firm's London office."
The JPMorgan Chase episode follows other incidents of U.S. firms with bad news related to their London offices. MF Global's U.K. affiliate was pulled into an investigation over whether the derivatives firm improperly transferred customer funds before its collapse. And at the height of the 2008 crisis, it was the London branch of AIG's Financial Products unit that seemed to be at the center of the company's losses.
Some experts say a lighter regulatory touch by U.K. authorities leading up to the crisis led to some firms basing certain riskier activities there.
"As a general matter, it has been historically true that the United Kingdom's regulatory schemes have been much weaker than those of the United States. It is for that reason that you see banks like JPMorgan have such a huge presence in London," said Michael Greenberger, a law professor at the University of Maryland and a former director of the trading and markets division at the Commodity Futures Trading Commission.
But Anat Admati, who teaches at Stanford University, said since the crisis, U.K. regulators have appeared more aggressive than their U.S. counterparts on supervising large companies.
"The U.K. is ahead of the U.S. on wanting to do the right things with regulation and supervision at the moment. The thinking is ahead, but they have their politics just the same," Admati said. "They have big banks that are powerful there, and they have the same competitiveness and playing-field arguments as well. But certainly their ideas are better.
"They have been much more vigilant in terms of building and maintaining capital in their banks. There are more people there, in the Bank of England, who want to be tougher. I wish the U.S. would collaborate with them more on those preventative measures — as much as they work with them on resolution."