Effective risk governance policies are the foundation of risk management at J.P. Morgan. They set the framework for how the firm identifies, measures, quantifies, controls, monitors and reports all types of risks it faces.

While managing the firm’s risks is the core responsibility of an experienced risk management group, risk management is the responsibility of every individual in the firm and is a top priority at all times, across economic and market cycles. Risk cannot be fully eliminated or avoided because it is intrinsic to many of the activities in which J.P. Morgan’s businesses engage. On the other hand, risk may be managed in several ways. Risks are controlled through limits and reduced through business strategies, transaction structuring and collateralization. Risks are taken factoring in risk/reward, earnings power, diversification and capital.

Securities Lending Risk Management
To manage risks in its Securities Lending business, J.P. Morgan adheres to these policies and uses a holistic approach to optimize the risk-adjusted return for the firm and for its clients. Risks are evaluated and monitored from multiple perspectives, are assessed qualitatively and quantitatively, and are managed dynamically through frequent discussions and a proactive and forward-looking focus. J.P. Morgan’s risk management group and the Securities Lending business interact very closely in this process with the common goal of properly managing all risks.

J.P. Morgan acts as agent and assumes principal risk in the Securities Lending business. Although J.P. Morgan acts as agent for its clients when lending their securities, it acts as a de facto principal for its indemnified securities loans because it takes the lender’s credit risk vis-à-vis the borrower and ensures the lender will receive either the securities it lent or their value back in the event of a borrower default. In that role, J.P. Morgan is protected by the collateral borrowers pledge against securities loans. J.P. Morgan acts as agent for the reinvestment of cash collateral under guidelines set by lenders and internal credit policies. The cash collateral reinvestment risk is borne by the lender.

Securities lending risk breaks down into several different risk types:

Counterparty Risk
Counterparty risk represents the risk of a borrower defaulting. This risk is managed through careful borrower selection supported by constant monitoring, due diligence and dialogue with borrowers. Internal risk ratings differentiate the credit quality of each borrower and their limits are set taking into account their credit risk and size and the overall risk of their transactions. Ratings, limits and transaction terms are continuously reassessed in light of each borrower’s credit quality.

Market Risk
Market risk in securities loans represents the risk associated with the prices of securities lent and held as collateral. This risk is managed through proper risk quantification, collateral eligibility and margin. This risk reflects the estimated potential loss if a borrower defaults and J.P. Morgan needs to liquidate the collateral it holds in order to buy back the lent securities. It is quantified through models that take into account volatilities and correlations of the underlying securities, as well as stress testing and simulation techniques that indicate possible losses in a range of different scenarios. This allows proactive and forward-looking management of market risk.

Operational Risk
Operational risk represents the risk of loss due to errors in processing. This risk is managed through robust controls, effective processes and detailed procedures that ensure proper and well-controlled, end-to-end transaction processing. This includes booking, pricing, margining and reporting. Internal control self-assessments and audits ensure proper oversight and support a reliable operational framework.

Investment Risk
Investment risk in cash collateral reinvestment represents the risk that investments expected to be held to maturity are not fully paid when they mature. This risk is borne by lenders. If a lender decides to sell an investment before its maturity, it will be exposed to risks such as the investment’s market value and liquidity. This risk is managed by J.P. Morgan through careful selection of issuers and investment types within investment guidelines set by each client. This also includes thorough selection of counterparties, as well as adequate collateral eligibility and margin, when the cash collateral reinvestment is made through reverse repo transactions.

Fiduciary Risk
Fiduciary risk represents the risk that J.P. Morgan fails to perform its fiduciary responsibilities on behalf of beneficiary lenders. These responsibilities require J.P. Morgan to act with prudence and in the best interest of clients when performing fiduciary functions. This implies a relationship of trust and confidence, as J.P. Morgan has the legal authority and the duty to make lending and investment decisions on behalf of beneficiary clients within guidelines and conditions they set for their securities lending business with J.P. Morgan. This risk is managed through solid fiduciary policies and procedures, reliable operations and controls, and close oversight by Fiduciary and Operational Risk Management, Compliance and Audit.

Summary
J.P. Morgan’s strong and effective focus on risk management has enabled it to weather challenging market conditions over the years, positions it extremely well to meet the challenges of today and the future, and represents a major competitive advantage for its Securities Lending business.