EU: 13 major banks may pay fines 10% of worldwide turnover

Joaquín Almunia, Vice-President of the European Commission in charge of Competition, gave a press conference on the statement of objections to 13 investment banks, ISDA and Markit in credit default swaps and derivatives investigation. (EC Audiovisual Services, 01/07/2013).

In a long-awaited decision, Joaquín Almunia, Vice President of the European Commission responsible for Competition Policy, accused thirteen western giant investment banking groups and two support bodies that those banks created a trust, setting prices in the over the counter trade of Credit Default Swaps and Derivatives, a multi trillion business. The Commission’s investigation covers the period before and after the financial crunch of 2008.

In detail, the Commission sent yesterday its official ‘objections’, according to Article 101 of the Treaty on the Functioning of the European Union (TFEU) to the following financial groups: 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 as well as to Markit, a financial information firm and the International Swaps and Derivatives Associations (ISDA). Both Markit and ISDA are controlled by those banks. The sending of this statement of objections is a key step in the ongoing antitrust investigation that the Commission opened in April 2011.

The Commission stresses now that “Any finding of infringement of EU antitrust rules may lead to the imposition of fines up to 10% of a company’s annual worldwide turnover, if the Commission considers it appropriate”. Almunia also added that “Following our investigation, we have reached the preliminary conclusion that these companies may have breached EU antitrust rules that prohibit anticompetitive agreements. More precisely, we consider that they may have coordinated their behaviour in order to jointly prevent (official) exchanges from entering the CDS market between 2006 and 2009”.

According to the European Commissioner Markit and ISDA plaid a crucial role, by preventing other prospective entrants from joining the CDS market. Indeed two major stock exchanges, the Deutsche Börse and the Chicago Mercantile Exchange (CME), attempted to launch central clearing and exchange trading of credit derivatives, for which there was already a widespread demand among investors.

Exclusive club

To launch these exchange-traded credit derivatives, however, the exchanges needed licenses for data and index benchmarks. But ISDA and Markit refused to provide these licenses because – according to Commission’s findings the banks had instructed them to do so. In addition, several investment banks sought to shut out exchanges in other ways, for example by coordinating among themselves the choice of their preferred clearing house. In the end, neither Deutsche Börse nor CME managed to enter the market.

In short the accused banks along with Markit and ISDA aimed at restricting the sale of CDS contracts only over the counter (OTC) and exclusively by the above banks and not through an organised and regulated market. In this way they arbitrarily charged prices to individual buyers of CDSs and derivatives, without the customers having any option to seek information on competitive pricing in an organised market platform. If the official exchanges had managed to enter the CDSs and derivatives market, they would have offered competitive and transparent pricing to buyers. On top of that the whole finacial system would have been more transparent, reliable and stable.

High demand

Investor demand for those financial products was at times very high. Pension and hedge funds, insurance companies and other investors couldn’t actually enter the prime market of sovereign and company debt, without securing their placement with a CDS. At the beginning of 2013 there were almost 2 million active CDS contracts world-wide, with more than €10 trillion gross notional amount (source: DTCC). The notional amount is the amount of debt the CDS contract is written on.

Obviously if it is confirmed that the banks collectively and effectively blocked the official exchanges from the CDS market, breaching the prohibition of anticompetitive agreements enshrined in the EU Treaty, the Commission could decide to impose sanctions and fines. On top of that Almunia added that “The EMIR regulation provides that standardised derivative contracts must be centrally cleared. In the review of the MIFID Directive the Commission also proposes that these derivatives should be traded on transparent and organised trading platforms. Our regulatory work also seeks to ensure that clear rules are in place for access to benchmarks”.

However, apart from the possibility that those banks have formed a trust in order to illegally increase their incomes at the expenses of the entire economy, simultaneously with this behaviour, they undermined the stability of the global financial system. Some of those events occurred before the financial crisis broke out in 2008, some later. Among other factors, this ongoing crisis was due to such systemic risks. Risks of this type are intrinsic to over-the-counter trading. If one bank defaults, others are quickly affected. The bankruptcy of Lehman Brothers has shown how this mechanism is capable of destabilising the entire system.

Usurping taxpayers’ money

In contrast, when trading occurs through an official exchange, counterparty risk is managed more strictly, especially because transactions are automatically settled in a central clearing house. Official clearing houses are liable if some counterparty goes bankrupt. In this way failures do not affect others. Presumably those banks didn’t pay much attention to all those problems, even if at the end they themselves run the risk to get caught in the fallout.

Unfortunately this last crisis proved that those major western banks counted on their size and in a way, when they went bankrupt after 2008, they actually blackmailed societies, governments and central banks to recapitalise them and replenish their liquidity. This is exactly what happened in our western world during the past five years.