The EU antitrust watchdog's investigation into whether 16 of the world's largest financial institutions illegally dominate a key derivatives product represents a serious threat. Unlike antitrust enforcers in the Justice Department in recent years, the Europeans mean business when it comes to protecting competition. Just ask Microsoft (MSFT).
The commission announced two probes today. The first focuses on whether big swaps dealers -- including Bank of America (BAC), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Morgan Stanley (MS) and Wells Fargo (WFC), along with big European banks -- and a financial data company called Markit collude in trading credit default swaps:
The commission said it had information that the 16 banks that act as dealers in the market give most of the pricing, index information and other data only to Markit, which is the leading financial information firm in the market.
"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," the commission said. "If proven, such behavior would be in violation of EU antitrust rules."The second investigation is looking into whether nine of the 16 above firms, including B of A, Citi, Goldman, JPMorgan and Morgan Stanley, are breaking EU antitrust law in working with a company called Intercontinental Exchange, or ICE, to set up a new derivatives clearinghouse. Among other things, the EC wants to determine if the firms are exploiting their market power to steer swaps trading to the new exchange.
From money trust to antitrust
That would make it all but impossible for other clearinghouses to enter the business, potentially raising the price of CDS for companies, pension funds and other investors that use the instruments to hedge their risks. Commodity Futures Trading Commission chief Gary Gensler has said that results in "higher costs to all Americans."
It would come as no surprise that global financial firms have locked up the swaps business. The derivatives business is dominated by a handful of firms, although whether illegally remains to be determined. What's certain is that antitrust and related concerns in the U.S. go way back in banking. Most famously, between the late 19th century and the early 1920s Wall Street firms collectively dubbed the "money trust" controlled the financial system and the issuance of credit. In 1947, the feds also filed a lawsuit against 17 investment banks (in a case formally known as United States v. Henry S. Morgan et al), although a federal judge eventually ruled against the government.
More recently, in the mid-1990s U.S. antitrust regulators busted "market-making" firms for having colluded over trading on Nasdaq. New rules were instituted, drastically cutting costs for investors. Just this past December, B of A got slapped with a $137 million fine for allegedly rigging the market for municipal bonds. And the CFTC last year looked into whether JPMorgan was abusing its position as a large seller of derivatives tied to precious metals in order to manipulate the price of silver.
Only the beginning?
There's no telling what the EC will find. But it doesn't typically launch such high-profile inquiries half-cocked. If the commission is going public with the probes, that means it already has ample evidence that there's a problem.
It's also hard to say at this point what sanctions the EC would administer if it concludes the banks are breaking the law. Those could range from big fines to a settlement under which the firms would agree to alter their trading arrangements with Markit and ICE (or both). Perhaps an even bigger concern for Wall Street -- the focus on credit swaps could be only the beginning of a broader investigation into banks' control over other derivative products.
Image from Flickr user Xavier HÃ¤pe via Wikimedia Commons, CC 2.0