JP Morgan Chase 2014 Annual Report Download - page 205

JPMorgan Chase & Co./2014 Annual Report 203
Note 6 – Derivative instruments
Derivative instruments enable end-users to modify or
mitigate exposure to credit or market risks. Counterparties
to a derivative contract seek to obtain risks and rewards
similar to those that could be obtained from purchasing or
selling a related cash instrument without having to
exchange upfront the full purchase or sales price. JPMorgan
Chase makes markets in derivatives for customers and also
uses derivatives to hedge or manage its own risk exposures.
Predominantly all of the Firm’s derivatives are entered into
for market-making or risk management purposes.
Market-making derivatives
The majority of the Firm’s derivatives are entered into for
market-making purposes. Customers use derivatives to
mitigate or modify interest rate, credit, foreign exchange,
equity and commodity risks. The Firm actively manages the
risks from its exposure to these derivatives by entering into
other derivative transactions or by purchasing or selling
other financial instruments that partially or fully offset the
exposure from client derivatives. The Firm also seeks to
earn a spread between the client derivatives and offsetting
positions, and from the remaining open risk positions.
Risk management derivatives
The Firm manages its market risk exposures using various
derivative instruments.
Interest rate contracts are used to minimize fluctuations in
earnings that are caused by changes in interest rates. Fixed-
rate assets and liabilities appreciate or depreciate in market
value as interest rates change. Similarly, interest income
and expense increases or decreases as a result of variable-
rate assets and liabilities resetting to current market rates,
and as a result of the repayment and subsequent
origination or issuance of fixed-rate assets and liabilities at
current market rates. Gains or losses on the derivative
instruments that are related to such assets and liabilities
are expected to substantially offset this variability in
earnings. The Firm generally uses interest rate swaps,
forwards and futures to manage the impact of interest rate
fluctuations on earnings.
Foreign currency forward contracts are used to manage the
foreign exchange risk associated with certain foreign
currency–denominated (i.e., non-U.S. dollar) assets and
liabilities and forecasted transactions, as well as the Firm’s
net investments in certain non-U.S. subsidiaries or branches
whose functional currencies are not the U.S. dollar. As a
result of fluctuations in foreign currencies, the U.S. dollar–
equivalent values of the foreign currency–denominated
assets and liabilities or forecasted revenue or expense
increase or decrease. Gains or losses on the derivative
instruments related to these foreign currency–denominated
assets or liabilities, or forecasted transactions, are expected
to substantially offset this variability.
Commodities contracts are used to manage the price risk of
certain commodities inventories. Gains or losses on these
derivative instruments are expected to substantially offset
the depreciation or appreciation of the related inventory.
Credit derivatives are used to manage the counterparty
credit risk associated with loans and lending-related
commitments. Credit derivatives compensate the purchaser
when the entity referenced in the contract experiences a
credit event, such as bankruptcy or a failure to pay an
obligation when due. Credit derivatives primarily consist of
credit default swaps. For a further discussion of credit
derivatives, see the discussion in the Credit derivatives
section on pages 213–215 of this Note.
For more information about risk management derivatives,
see the risk management derivatives gains and losses table
on page 213 of this Note, and the hedge accounting gains
and losses tables on pages 211–213 of this Note.
Derivative counterparties and settlement types
The Firm enters into OTC derivatives, which are negotiated
and settled bilaterally with the derivative counterparty. The
Firm also enters into, as principal, certain exchange-traded
derivatives (“ETD”) such as futures and options, and
“cleared” over-the-counter (“OTC-cleared”) derivative
contracts with central counterparties (“CCPs”). ETD
contracts are generally standardized contracts traded on an
exchange and cleared by the CCP, which is the counterparty
from the inception of the transactions. OTC-cleared
derivatives are traded on a bilateral basis and then novated
to the CCP for clearing.
Derivative Clearing Services
The Firm provides clearing services for clients where the
Firm acts as a clearing member with respect to certain
derivative exchanges and clearinghouses. The Firm does not
reflect the clients’ derivative contracts in its Consolidated
Financial Statements. For further information on the Firm’s
clearing services, see Note 29.
Accounting for derivatives
All free-standing derivatives that the Firm executes for its
own account are required to be recorded on the
Consolidated balance sheets at fair value.
As permitted under U.S. GAAP, the Firm nets derivative
assets and liabilities, and the related cash collateral
receivables and payables, when a legally enforceable
master netting agreement exists between the Firm and the
derivative counterparty. For further discussion of the
offsetting of assets and liabilities, see Note 1. The
accounting for changes in value of a derivative depends on
whether or not the transaction has been designated and
qualifies for hedge accounting. Derivatives that are not
designated as hedges are reported and measured at fair
value through earnings. The tabular disclosures on pages
207–213 of this Note provide additional information on the
amount of, and reporting for, derivative assets, liabilities,
gains and losses. For further discussion of derivatives
embedded in structured notes, see Notes 3 and 4.