JP Morgan Chase 2010 Annual Report Download - page 147

JPMorgan Chase & Co./2010 Annual Report 147
PRIVATE EQUITY RISK MANAGEMENT
The Firm makes principal investments in private equity. The illiquid
nature and long-term holding periods associated with these in-
vestments differentiates private equity risk from the risk of positions
held in the trading portfolios. The Firm’s approach to managing
private equity risk is consistent with the Firm’s general risk govern-
ance structure. Controls are in place establishing expected levels for
total and annual investment in order to control the overall size of
the portfolios. Industry and geographic concentration limits are in
place and intended to ensure diversification of the portfolios. All
investments are approved by investment committees that include
executives who are not part of the investing businesses. An inde-
pendent valuation function is responsible for reviewing the appro-
priateness of the carrying values of private equity investments in
accordance with relevant accounting policies. At December 31,
2010 and 2009, the carrying value of the Private Equity portfolio
was $8.7 billion and $7.3 billion, respectively, of which $875
million and $762 million, respectively, represented publicly-traded
positions. For further information on the Private Equity portfolio,
see page 90 of this Annual Report.
OPERATIONAL RISK MANAGEMENT
Operational risk is the risk of loss resulting from inadequate or failed
processes or systems, human factors or external events.
Overview
Operational risk is inherent in each of the Firm’s businesses and
support activities. Operational risk can manifest itself in various ways,
including errors, fraudulent acts, business interruptions, inappropriate
behavior of employees, or vendors that do not perform in accordance
with their arrangements. These events could result in financial losses
and other damage to the Firm, including reputational harm.
To monitor and control operational risk, the Firm maintains a system
of comprehensive policies and a control framework designed to
provide a sound and well-controlled operational environment. The
goal is to keep operational risk at appropriate levels, in light of the
Firm’s financial strength, the characteristics of its businesses, the
markets in which it operates, and the competitive and regulatory
environment to which it is subject. Notwithstanding these control
measures, the Firm incurs operational losses.
The Firm’s approach to operational risk management is intended to
mitigate such losses by supplementing traditional control-based
approaches to operational risk with risk measures, tools and disci-
plines that are risk-specific, consistently applied and utilized firmwide.
Key themes are transparency of information, escalation of key issues
and accountability for issue resolution.
One of the ways operational risk is mitigated is through insurance
maintained by the Firm. The Firm purchases insurance to be in com-
pliance with local laws and regulations, as well as to serve other
needs of the Firm. Insurance may also be required by third parties
with whom the Firm does business. The insurance purchased is
reviewed and approved by senior management.
The Firm’s operational risk framework is supported by Phoenix, an
internally designed operational risk software tool. Phoenix integrates
the individual components of the operational risk management
framework into a unified, web-based tool. Phoenix enhances the
capture, reporting and analysis of operational risk data by enabling
risk identification, measurement, monitoring, reporting and analysis
to be done in an integrated manner, thereby enabling efficiencies in
the Firm’s monitoring and management of its operational risk.
For purposes of identification, monitoring, reporting and analysis, the
Firm categorizes operational risk events as follows:
• Client service and selection
• Business practices
• Fraud, theft and malice
• Execution, delivery and process management
• Employee disputes
• Disasters and public safety
• Technology and infrastructure failures
Risk identification
Risk identification is the recognition of the operational risk events that
management believes may give rise to operational losses. All busi-
nesses utilize the Firm’s standard self-assessment process and sup-
porting architecture as a dynamic risk management tool. The goal of
the self-assessment process is for each business to identify the key
operational risks specific to its environment and assess the degree to
which it maintains appropriate controls. Action plans are developed
for control issues that are identified, and businesses are held ac-
countable for tracking and resolving these issues on a timely basis.
Risk measurement
Operational risk is measured for each business on the basis of histori-
cal loss experience using a statistically based loss-distribution ap-
proach. The current business environment, potential stress scenarios
and measures of the control environment are then factored into the
statistical measure in determining firmwide operational risk capital.
This methodology is designed to comply with the advanced meas-
urement rules under the Basel II Framework.
Risk monitoring
The Firm has a process for monitoring operational risk-event data,
permitting analysis of errors and losses as well as trends. Such analy-
sis, performed both at a line-of-business level and by risk-event type,
enables identification of the causes associated with risk events faced
by the businesses. Where available, the internal data can be supple-
mented with external data for comparative analysis with industry
patterns. The data reported enables the Firm to back-test against self-
assessment results. The Firm is a founding member of the Operational
Riskdata eXchange Association, a not-for-profit industry association
formed for the purpose of collecting operational loss data, sharing
data in an anonymous form and benchmarking results back to mem-