Credit derivatives probe: new aggressiveness at the DOJ

The DOJ confirmed yesterday that its Antitrust Division is investigating possible anti-competitive practices involving credit derivatives.  The statement read:  “The Antitrust Division is investigating the possibility of anti-competitive practices in the credit derivatives clearing, trading and information services industries.”

The statement came the day after Markit Ltd, a dealer-owned provider of prices in the credit default swap market, said the DOJ was investigating the $26.5 trillion market:  “Markit has been informed of an investigation by the Department of Justice into the credit derivatives and related markets.”  It did not specify the targets of the probe.

The DOJ sent civil investigative demands (CIDs) early this month to the largest dealers in the CDS market, seeking detailed information about their CDS exposures and their relationship to Markit, according to people familiar with the letters, who also indicated the requests are voluminous.  The issuance of CIDs on such a scale normally results in large scale document reviews. 

The Justice Department is thought to be looking into whether dealers that have an equity stake in Markit have any unfair advantage over other market participants relating to CDS price information, analysts said.

The following is from today’s Financial Times:

Credit derivatives probe opens new ‘can of worms’

Published: July 16 2009

The future shape of the credit derivatives market was already difficult to sketch out. With regulators and market participants immersed in a tussle over how much of it needs to be centrally cleared in order to reduce risks to the financial system, much debate has ensued about what form this market will take.

Now, a new set of questions is making the rounds as the US Department of Justice investigates the $26,000bn credit derivatives market’s main data provider, Markit, and the dealers that control it for potential anti-competitive behaviour.

“It is opening another can of worms,” said Joel Telpner, partner at Mayer Brown. “Many of the initiatives so far, such as the move towards centralised clearing, would not change anything in terms of how contracts are priced.” He said it was unclear where the DoJ’s probe would lead – and whether it would change the structure of the market, which is dominated by a handful of large Wall Street firms – but it could have a significant impact.

While the DoJ’s anti-trust division has traditionally kept a close eye on financial markets, it has taken few enforcement actions in the last eight years when the Bush administration took a more hands-off attitude to competition.

The probe into the unregulated CDS market shows a new aggressiveness at the DoJ when it comes to anti-trust – or anti-competitive – matters. Under the Sherman Act, which prohibits abuses of monopoly power, it has requested huge amounts of pricing and trading activity information going back several years.

“This is a sea-change from the past eight years,” said Harvey Goldschmid, a law professor at Columbia University and a former commissioner at the Securities and Exchange Commission. “The present anti-trust division leadership is very different and far more concerned about traditional anti-trust values than the group that led the division during the last eight years. This is a group that takes anti-trust seriously and the need for competitive markets seriously.”

Christine Varney, newly appointed assistant attorney-general in charge of antitrust policy, has indicated a desire to return to an active interpretation of the 1890 Sherman Act.

Credit derivatives in the last decade became one of Wall Street’s most profitable segments, with a small group of banks such as JP Morgan Chase, Goldman Sachs, Citigroup and Morgan Stanley involved.

“Lack of transparency can lead to the appearance of smoke and, in the current political climate, a hint of smoke leads to the assumption of fire,” said Tim Backshall, chief strategist at Credit Derivatives Research. Banks that have received DoJ requests are trying to assess just how much information they need to collect. It is likely to be an arduous task. 

Richard Epstein, law professor at the University of Chicago, said: “This is a big investigation which necessarily gives DOJ officials lots of discretion.”