Major banks are facing increased scrutiny in the EU, where a competition watchdog is investigating their practices, as well as a financial data firm and a clearing house, in the market for credit default swaps. During the financial crisis, a common criticism arose that there was a lack of transparency. The two probes launched are aimed at pulling back the curtain and gaining a clearer picture of what actually occurs in the market.
While the investigations focus on competition issues, they accompany a wider regulatory crackdown in Europe and the United States on credit default swaps and other derivatives and could have implications for the broader functioning of the market. The European Commission said it has “indications” that the 16 banks acting as dealers in the CDS market give essential information on pricing and other daily activities only to Markit, the leading financial data provider for that market. The Commission said that preferential treatment like this “could be the consequence of collusion between them or an abuse of a possible collective dominance” and could lock other data providers out of the CDS business.
The list of firms targeted is a veritable who’s who of the banking industry, including the likes of JP Morgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), Citigroup (NYSE: C), Goldman Sachs (NYSE: GS), Wells Fargo (NYSE: WFC), and many others, all of which are shareholders in Markit.
Credit default swaps were invented to help investors insure themselves against the default of a company or a state whose bonds they hold. However, they have also been used for speculation, with banks and hedge funds trading in CDS to make money without actually owning the underlying bonds. The CDS market was at the center of the financial crisis, as rising spreads forced many banks to the brink of bankruptcy. Joaquin Almunia, the EU’s competition commissioner, said in a statement “CDS play a useful role for financial markets and for the economy. Recent developments have shown, however, that the trading of this asset class suffers a number of inefficiencies that cannot be solved through regulation alone.”
The near-monopoly of financial data, like the one held by Markit in the CDS market, could leave smaller players with worse information on pricing and ultimately a worse deal. The probes were launched after regulators discovered suspicious market structure during their exam of the CDS market, and hopefully this increased scrutiny will decrease the likelihood of similar issues recurring.