World’s Biggest Banks Face EU Collusion Claims

(CN) - The European Commission announced tentative findings that 13 of the world's largest banks colluded to bar exchanges from the risky credit default swap business.

In a statement Monday, Europe's regulatory body said it had informed the banks - as well as the International Swaps and Derivatives Association (ISDA) and its data-service provider Markit - that they had infringed EU antitrust rules.

The banks include Bank of America-Merrill Lynch, Barclay's, Bear Stearns, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, Royal Bank of Scotland and UBS.

Commissioners said Deutsche Borse and the Chicago Mercantile Exchange tried to enter the credit derivatives business between 2006 and 2009, and applied to ISDA and Markit for the necessary licenses for data and benchmark indexes. But the banks - which control ISDA and Markit - ordered them to license the exchanges for over-the-counter trading only, which is more expensive and carries higher risk than exchange trading.

Regulators believe the banks feared exchange trading would reduce their revenue stemming from their role as intermediaries on the OTC market so they acted collectively to shut the exchanges out of the market.

"It would be unacceptable if banks collectively blocked exchanges to protect their revenues from over-the-counter trading of credit derivatives," Joaquin Almunia, the commission's vice president in charge of competition, said in a statement. "Over-the-counter trading is not only more expensive for investors than exchange trading, it is also prone to systemic risks."

Investors and hedge fund managers use derivative contracts known as credit default swaps to transfer the default risk linked to the debt obligation laid out in the contract. In addition to providing protection from default, the scheme can also be used to bet on the future creditworthiness of the issuer and turn a profit if the view is correct.

During the period in question, derivatives were traded over-the-counter and were privately and bilaterally negotiated. In OTC trading the banks act as intermediaries between supply and demand for the derivative contracts by promising to "be a seller to every buyer and to be a buyer to every seller," the commission said.

Exchange trading, however, matches supply and demand on the exchange's trading platform. This makes the credit-default swap contracts safer and more transparent, a commission goal after the worldwide economic crisis of 2007 to 2010.

Regulators estimate that there are currently 2 million active derivatives contracts, with a face or notional value of over $13 trillion. The value of credit default swaps has fallen steadily since 2007, when the amount of outstanding contracts exceeded $62 trillion.

At this stage in the commission's investigation - ongoing since 2011 - the banks can request a hearing to launch a defense and examine investigation records. If regulators still find antitrust infringement after the defense, the banks face fines of up to 10 percent of their worldwide annual revenue.

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