December 3, 2023

DealBook: Europe Investigating Banks Over Credit Swaps

11:05 a.m. | Updated European Union antitrust regulators announced on Friday two sweeping antitrust investigations into the world’s largest banks and their roles in a market for derivatives where a small number of companies control trillions of dollars of financial instruments.

The European officials are looking at whether banks, including Barclays and Goldman Sachs, have harmed rival organizations that could compete in markets for providing information and clearing a form of transaction that had become critical to the smooth functioning of the entire economy.

“Lack of transparency in markets can lead to abusive behavior and facilitate violations of competition rules,” the European Union antitrust commissioner, Joaquin Almunia, said in a statement. “I hope our investigation will contribute to a better functioning of financial markets and, therefore, to more sustainable recovery.”

The inquiry follows an examination of that market last year by The New York Times that highlighted efforts by banks like JPMorgan Chase, Deutsche Bank, Goldman Sachs and others to control access to the derivatives market, even as global regulators try to bring transparency and safety to a murky corner of the financial world.

Derivatives — instruments that shift risk from one party to another — added to the panic during the financial crisis, because banks and regulators did not know all the parties involved in trillions of dollars of interweaving contracts.

The roughly $600 trillion market is controlled by a small number of players, concentration that has raised competition concerns in recent years. Those banks have recently taken many steps to try to hold on to their advantages in the market, even as regulators have tried to exert greater control over the market.

The European Commission inquiry is focused on one type of derivative known as a credit default swap, which is essentially an insurance contract. They are widely used in stock investing and mortgage investing, when an investor wants to bet against a company’s bond or a mortgage bond. They are frequently used as a measure of the credit worthiness of companies and governments and have become a crucial component in gauging borrowing costs.

The commission has previously estimated the value of all the positions on the market for credit default swaps to be $21.5 trillion, with about $3.27 trillion of that amount representing position on the market for credit default swaps in sovereign debt.

The banks are involved in two crucial components of the market for credit default swaps.

Sixteen of the banks are shareholders in Markit, a London-based organization that is the leading provider information on the market for credit default swaps. European Union officials suspect that the banks’ arrangements with Markit could effectively lock out other data providers.

Nine of the banks involved also have a financial relationship with the IntercontinentalExchange, a public company that owns ICE Clear Europe and ICE Clear U.S. That company is involved in a new business area known as clearing — which regulators are promoting as a way to bring more safety to the derivatives market. The banks had been creating their own effort to clear derivatives through a company they owned called the Clearing Corporation. In 2008, they sold that company to ICE, which was developing its own business. In exchange, ICE allowed the banks to influence the way the clearing business was set up and also granted them multiyear price breaks on clearing fees.

Critics say the banks worked with ICE to create rules and practices that were anticompetitive, like membership rules that for a while blocked other brokers from signing up to do business there.

Amelia Torres, a spokeswoman for Mr. Almunia, said that officials began the investigation without receiving formal complaints from competitors but said wrongdoing would be “obviously harming other players in the market.”

ThomsonReuters, Standard Poor’s and Bloomberg are among companies that could compete with Markit provide information on trading credit default swaps. Eurex and L.C.H. Clearnet are among the companies that also provide clearing services for credit default swaps.

The derivatives market has exploded in size since the 1990s as more companies and investors looked for ways to take positions in commodities, corporate defaults, mortgages and other assets without having to purchase actual goods.

Derivatives allow one party — usually a bank — to give customers exposure to price changes in goods through a written agreement to pay based on changing prices.

The Justice Department has also been investigating this market and told The Times in December that its inquiry was focused on “the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries.”

The Justice Department began its investigation of Markit in the summer of 2009, and by last fall it had expanded into looking at clearing practices between companies like ICE and the banks. The Chicago Mercantile Exchange also has a clearing house business and has partnered with the banks to develop it.

The European Commission was in frequent contact with the Department of Justice and the Federal Trade Commission about the investigations announced on Friday, but it had received no indications that their United States counterparts were still actively pursuing similar investigations, said European Union officials who spoke on condition of anonymity because they were not allowed to speak publicly. The European Commission’s investigation may increase the pressure on the Department of Justice to take action.

European regulators could fine the banks involved in the case up to 10 percent of their global annual sales for the kinds of antitrust and cartel violations that officials are investigating in Europe.

Even so, the commission may find other ways to inject greater competition into the market. The commission has increasingly favored settling major investigations to win quicker results, and it could waive fines if the banks agreed to adjust their contracts with Markit and ICE Europe.

The banks named in the investigation are JPMorgan, Bank of America, Barclays, BNP Paribas, Citigroup, Commerzbank, Crédit Suisse, Deutsche Bank, Goldman Sachs, HSBC, Morgan Stanley, Royal Bank of Scotland, UBS, Wells Fargo, Crédit Agricole and Société Générale. All of these banks declined to comment or did not return an inquiry. The IntercontinentalExchange did not reply to a request to comment.

Markit issued a statement defending its actions.

The company said it “has no exclusive arrangements with any data provider and makes its data and related products widely available to global market participants.” It said it was “unaware of any collusion by other market participants as described by the commission.”

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