European Union

Bank margins at risk as EU probes credit-default swaps market

U.S. and European Union regulatory crackdowns on credit-default swaps threaten to erode the largest banks' control over the $30tn market.

The EU is examining whether 16 investment banks, including Goldman Sachs Group Inc., JPMorgan Chase & Co. and Deutsche Bank AG, colluded in giving information to Markit Group Ltd., a data provider majority-owned by Wall Street's biggest lenders. Regulators also will probe whether nine of the firms struck unfair deals with Intercontinental Exchange Inc.'s European derivatives clearinghouse, shutting out rivals.

Global regulators have sought to toughen oversight of the market for credit-default swaps, which were blamed for contributing to the biggest financial crisis since the Great Depression. The U.S. Justice Department began an investigation into the derivatives in July 2009 to determine if companies have unfair access to price information.

"The undertones through this whole process have been to take power away from the big banks," said Kevin McPartland, a senior analyst with Tabb Group in New York. "This seems like another sort of attack on the banks."

Ownership of the data provider may give banks access to price information before it's available to the rest of the market, according to Mark Williams, a former Federal Reserve examiner who teaches finance at Boston University. Regulators said it also may block competitors and limit access for other swaps dealers.

'Abusive behavior'

"Lack of transparency in markets can lead to abusive behavior and facilitate violations of competition rules," Joaquin Almunia, the EU's competition commissioner, said in an e-mailed statement. "I hope our investigation will contribute to a better functioning of financial markets."

Dealer trades account for more than $23tn of the outstanding gross notional credit-default swaps market, according to the Depository Trust & Clearing Corp., which runs a central repository for the market.

The EU's probes add to separate investigations in the U.K. and U.S. into whether banks colluded to manipulate the London interbank offered rate.

The credit-default swap investigations are the first by antitrust regulators in Europe. The U.S. Justice Department's probe of the credit derivatives clearing, trading and information services industries is "ongoing," said Alisa Finelli, a spokeswoman. The department first confirmed the investigation in July 2009. She declined to comment further.

Markit "does not believe it has engaged in any inappropriate conduct," Michael Gormley, a spokesman for the company in New York, said in an e-mailed statement. Bloomberg LP, the owner of Bloomberg News, competes with Markit in selling information to the financial-services industry.

Greek crisis

German Chancellor Angela Merkel and French President Nicolas Sarkozy called last year for the European Union to ban the use of credit-default swaps by investors to profit from defaults on government bonds they don't own. Merkel and Sarkozy blamed so-called naked short-selling for worsening Greece's debt crisis, which later spread to other euro-area countries.

"Antitrust authorities going around like a bull in a china shop could wreak huge damage and undermine their efforts" to encourage clearinghouses as a means of reducing risk, Craig Pirrong, a finance professor at the University of Houston, said in an interview.

Bank of America Corp., Barclays Plc, BNP Paribas SA, Commerzbank AG, Credit Suisse Group AG, HSBC Holdings Plc, Morgan Stanley, Citigroup Inc., Royal Bank of Scotland Group Plc, UBS AG, Wells Fargo & Co., Credit Agricole SA and Societe Generale SA will also be investigated for possible collusion in giving "most of the pricing, indices and other essential daily data only to Markit," EU regulators said.

1,500 customers

Markit provides data on debt and derivatives to more than 1,500 customers. It owns the most actively traded credit swap indexes and pricing services in the market.

Markit "has no exclusive arrangements" with any data provider and is "unaware of any collusion by other market participants," Gormley said.

The EU will also separately investigate credit-default swap clearing agreements struck by ICE Clear Europe with Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Morgan Stanley and UBS.

"Banks have taken charge not because they're being good Samaritans in these exchanges, but because they see a profit opportunity," Boston University's Williams said.

Kelly Loeffler, an ICE spokeswoman, declined to comment. The company's U.S. clearing arm is owned by dealers including JPMorgan, Goldman Sachs and UBS.

Creating incentives

Goldman Sachs declined to comment on the probe, said Michael Duvally, a spokesman for the bank in London.

Deutsche Bank, Commerzbank, JPMorgan, Bank of America, BNP Paribas, Morgan Stanley, Barclays, UBS, Credit Suisse, RBS, Societe Generale, HSBC, Wells Fargo and Citigroup also declined to comment.

The agreements with ICE have clauses on preferential fees and profit-sharing arrangements "which might create an incentive for the banks to use only ICE as a clearinghouse," the EU said. That may block other clearinghouses from starting up and limit choice for CDS dealers, it said.

The investigation also will cover fee structures used by ICE to check if they give "an unfair advantage to the nine banks by discriminating against other CDS dealers," the EU said.

Antitrust complaint

The commission must send companies an antitrust complaint before it takes any decision to fine them up to 10% of yearly revenue. Businesses may avoid fines if they agree to change contracts that harm competition. There's no legal deadline to end an investigation.

"I can't imagine that there'll be a large punishment for banks because the probe seems to be about delivering information and not about demanding too high prices from clients or price fixing," Philipp Haessler, a Frankfurt-based analyst at Equinet AG, said in an e-mail.

Credit-default swaps are derivatives that pay the buyer face value if a borrower defaults less the value of the defaulted debt. Lawmakers in the EU plan to encourage the use of clearinghouses and transparent trading systems.

Clearinghouses operate as central counterparties for every buy and sell order executed by their members, who post margin and contribute to default funds, reducing the possible risks that a derivatives trade may collapse.

Dealers of credit-default swaps in Europe bowed to pressure from the EU in 2009 to conduct trades through clearinghouses, such as ICE Clear, to cut risk to the financial system.

(Published by Bloomberg - May 2, 2011)


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