EUROPEAN COMMISSION INVESTIGATION CONCLUDES EU ANTITRUST INFRINGEMENT

A two-year European Commission investigation has preliminarily concluded that some of the world’s largest investment banks -in addition to two bodies that they control:  Markit and the International Swaps and Derivatives Associations (ISDA) -have infringed EU antitrust rules by colluding to prevent exchanges from entering the credit derivatives market between 2006 and 2009. As a result, rival firms were unable to set up competitive clearing trading platforms and the banks under investigation were able to maintain their position as intermediaries for CDS transactions. The banks involved are Bank of America, Merrill Lynch, Barclays, Bear Stearns (now part of JP Morgan), BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, UBS and the Royal Bank of Scotland. The CDS investigation is one of several by the European Commission into the financial industry (e.g., the investigation into U.K. (Libor) and European (Euribor) benchmark interest rate manipulation). The EU investigation follows a similar probe by the U.S Justice Department into potentially anticompetitive practices in the CDS market.

CDS market: background

A credit default swap (CDS) is a derivative contract designed to transfer the credit risk (i.e., the risk of default) linked to a debt obligation referenced in a contract. CDS are by far the most important type of credit derivatives. In 2013, there were almost 2 million active CDS contracts world-wide exceeding €10 trillion in gross nominal amount [Source: Depository Trust & Clearing Corporation]. In the period under investigation (2006-2009), CDS were privately and bilaterally negotiated between banks (over-the-counter or “OTC”) rather than on an exchange. In OTC transactions, investment banks act as intermediaries matching supply and demand in the market for credit derivatives thereby rendering the banks indispensable for CDS trading. By contrast, exchange trading automatically matches supply and demand on an exchange’s trading platform and constitutes, according to the  European Commission, a safer, less costly way of dealing.

Antitrust investigation by the European Commission

On 29 April 2011, the European Commission announced that it had opened two separate investigations into suspected breaches of Article 101 and/or Article 102 of the Treaty on the Functioning of the European Union (TFEU) in the CDS market.

The first investigation concerns the CDS information market, focusing on 16 banks active on the CDS market which supply their transaction data (pricing and indices) exclusively to Markit, the leading financial information provider in the CDS market, owned  in part by the same banks. The European Commission is investigating allegations that other information providers were excluded from this market either because of collusion between the banks (contrary to Article 101 TFEU) or as the result of abuse of a position of collective dominance (contrary to Article 102).

The second investigation concerns the CDS clearing market. The investigation focuses on a series of agreements between nine of the same banks and ICE Clear Europe (ICE), a clearing house. A number of clauses were included in the agreements (profit-sharing agreements) which arguably had the effect of incentivizing banks to use ICE exclusively as a clearing house. As a result, other clearing houses may have had difficulties entering the market and other CDS players may have been deprived of a real choice as to their transaction clearing options.

During its investigation of the CDS information market, the Commission found preliminary indications that the International Swaps and Derivatives Association (ISDA), a professional organisation involved in the trading of OTC derivatives, may have colluded with investment banks to delay or prevent exchanges from entering the credit derivatives market. Consequently, on 26 March 2013, the Commission announced that it had extended its investigation of the CDS information market to include ISDA. On 1 July 2013, the European Commission sent a statement of objections to 13 investment banks, as well as to ISDA and Markit, alleging that they had colluded to prevent exchanges from entering the credit derivatives market between 2006 and 2009, in breach of Article 101 TFEU. According to the Commission’s preliminary view, the banks colluded in this way due to fears that exchange trading would reduce their revenues from acting as intermediaries in the OTC market.

The European Commission reached the preliminary conclusion that the companies under investigation may have coordinated their behaviour in order jointly to prevent exchanges from entering the CDS market between 2006 and 2009. German Exchange Deutsche Boerse and U.S. commodities exchange the Chicago Mercantile Exchange attempted unsuccessfully  to enter the market and launch central clearing and exchange trading of CDS, for which there was a widespread demand among investors. In order to launch exchange-traded credit derivatives, the exchanges needed licences for data and index benchmarks, which ISDA and Markit refused to provide. The two companies were unable to obtain CDS exchange-trading licences from Markit and ISDA, which were allegedly acting on instructions from investment banks. As a consequence, Deutsche Boerse and the Chicago Mercantile Exchange were unable to enter the market.

The separate investigation introduced by the European Commission into the CDS clearing market is still active.

What’s next ?

A statement of objections is a formal step in Commission investigations into suspected violations of EU antitrust rules. It does not prejudge the outcome of the investigation. If, after the parties have exercised their rights of defence, the Commission concludes that there has been an infringement of competition rules, it can issue a decision prohibiting the conduct and impose a fine of up to 10% of a firm’s annual worldwide turnover. Rumours from Brussels suggest that settlement negotiations between the banks and the Commission are currently underway. In a typical settlement case, the parties under investigation decide, having seen the evidence in the Commission’s file, agree to acknowledge their involvement in the cartel and their liability for it. In exchange, the Commission reduces the fine that it would otherwise have imposed by 10 per cent. In total, seven cartels have been settled pursuant to the settlement procedure since the introduction of a settlement option by the Commission in 2008.