Saturday, April 30, 2011

European Commission Investigates Possible Antitrust Violations in Derivatives while US Engages in Watchful Waiting

The European Commission has opened two antitrust investigations concerning the credit default swaps market. In the first case, the Commission will examine whether 16 investment banks and Markit, the leading provider of financial information in the CDS market, have colluded and/or may hold and abuse a dominant position in order to control the financial information on CDS. If proven, such behavior would be a violation of EU antitrust rules. In the second case, the Commission opened proceedings against 9 of the banks and ICE Clear Europe, the leading clearing house for CDS. Here, the Commission will investigate in particular whether the preferential tariffs granted by ICE to the 9 banks have the effect of locking them in the ICE system to the detriment of competitors. In the EU, there is no legal deadline to complete antitrust investigations. The duration depends on a number of substantial and procedural factors.

Credit default swaps are financial products traded between financial institutions or investors. They are derivatives originally created to provide protection against the risk of default. Today, CDS are also used for speculation. Information about CDS is needed to allow market participants to determine the value of their investment portfolios and develop investment strategies. In order to create and sell aggregated CDS information products and services, information service providers need access to a certain amount of CDS transaction and valuation data.

The first case will investigate privileged access to CDS transaction data by Markit. The second will examine the existence of preferential treatment by ICE Clear, a CDS clearing platform, of some well established banks who themselves promote this platform at the expense of others. Lack of transparency in markets can lead to abusive behavior and facilitate violations of competition rules, said Joaquín Almunia Commission Vice President in charge of Competition Policy

The first investigation focuses on the financial information necessary for trading CDS. The Commission has indications that the 16 banks that act as dealers in the CDS market give most of the pricing, indices and other essential daily data only to Markit, the leading financial information company in the market concerned. This could be the consequence of collusion between them or an abuse of a possible collective dominance and may have the effect of foreclosing the access to the valuable raw data by other information service providers. If proven, such behaviour would be in violation of EU antitrust rules. The 16 CDS bank dealers are: JP Morgan, Bank of America Merrill Lynch, Barclays, BNP Paribas, Citigroup, Commerzbank, Crédit Suisse First Boston, Deutsche Bank, Goldman Sachs, HSBC, Morgan Stanley, Royal Bank of Scotland, UBS, Wells Fargo Bank/Wachovia, Crédit Agricole and Société Générale.

The probe will also examine the behavior of Markit, a UK-based company created originally to enhance transparency in the CDS market. The Commission is now concerned certain clauses in Markit's licence and distribution agreements could be abusive and impede the development of competition in the market for the provision of CDS information.

In the second case, the Commission is investigating a number of agreements between nine of the above 16 CDS dealers and ICE Clear Europe. These agreements were concluded at the time of the sale, by the dealers, of a company called The Clearing Corporation to ICE. They contain a number of clauses (preferential fees and profit sharing arrangements) which might create an incentive for the banks to use only ICE as a clearing house. The effects of these agreements could be that other clearing houses have difficulties successfully entering the market and that other CDS players have no real choice where to clear their transactions. The Commission will also investigate whether the fee structures used by ICE give an unfair advantage to the nine banks, by discriminating against other CDS dealers.

In a letter to the SEC late last year, antitrust officials at the Department of Justice, while strongly supporting the SEC's efforts to create meaningful limits on ownership of swap execution facilities and Exchanges, as well as its proposed use of governance restrictions as a separate safeguard against conflicts of interest, expressed concern that the proposed ownership limits for swap execution facilities and Exchanges, which include individual share thresholds but no aggregate cap on ownership by participants or members, will not sufficiently reduce the risk that major dealers may control a swap execution facility or Exchange to restrict competition among dealers and other market participants. In the Department's view, limiting both individual
ownership shares and the aggregate shares held by major dealers would be the most effective structural approach to protecting competition in the derivatives markets.

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