Antitrust Law Daily Wrap Up, ANTITRUST NEWS: Banks conspired to prevent exchange trading in interest rate swaps market, complaint charges, (Jun 1, 2016)

By Edward L. Puzzo, J.D.

Financial institutions that controlled the sell side of the over-the-counter market for interest rate swaps engaged in a conspiracy to block the transition to a more transparent electronic exchange-style trading system in order to maintain their lucrative position as rent-seeking intermediaries, causing institutional investors to pay supra-competitive prices, according to a class action complaint filed in the federal district court in New York City (Kansas City, Missouri Employees' Retirement System v. Bank of America Corporation, May 27, 2016).

Interest rate swaps. Interest rate swaps (IRS) are a type of financial derivative instrument used by investors to hedge against interest rate fluctuations or to speculate on the direction of interest rates. Commonly, for a fixed amount of principal and a fixed period of time, one party will agree to pay its counterparty a fixed rate of interest in exchange for a floating, market-based rate. IRS are widely used by institutional investors, such as pension funds and municipalities, collectively known as the “buy-side” of the IRS market. The "sell-side" of that market consists of the defendants—Bank of America, Barclays, BNPP, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS, and UBS—who are the primary and dominant dealers of IRS in the United States and serve as the largest IRA market makers; i.e., the primary dealers willing to enter either side of an IRS transaction with a customer.

OTC vs. electronic trading. As the IRS market developed in the 1980s and 1990s, IRS transactions were executed on an over-the-counter (OTC) basis; that is, through direct bilateral negotiations between a dealer (typically, one of the defendant institutions) and a buy-side entity. Plaintiffs allege that OTC trading is highly favorable to the defendant institutions because it limits the buy-side’s ability to comparison shop using real-time price information. Further, the OTC system entrenches the defendant institutions as necessary parties to most trades, enhancing their collective market power, the complaint alleges. In contrast, the complaint alleges, electronic exchange-style trading platforms—in which a centralized exchange serves the market-making function of accepting bids and offers from anonymous market participants to match willing buyers and sellers at a competitive real-time price—offer much more price transparency than OTC trading systems, with substantial benefits for competition because of improved price discovery and liquidity.

The complaint alleges that, for many financial products including derivative instruments, the trend in recent years has been away from OTC trading towards electronic exchange-style trading. However, because this trend eliminates the need for the traditional market makers, it jeopardizes the defendants' lucrative role as rent-seeking intermediaries in this $1 trillion per day market. Consequently, it is alleged, the defendants used their collective market power to boycott and collusively target would-be competitors offering an exchange-like platform for executing standardized IRS transactions.

Anticompetitive behavior. Defendants are accused of engaging in two broad categories of anticompetitive conduct aimed at blocking exchange-style execution for buy-side users of IRS: (1) group boycotts and other anticompetitive conduct to block upstart IRS platforms that threatened to disrupt the status quo, and (2) group boycotts and other anticompetitive conduct to prevent existing inter-dealer trading platforms from allowing buy-side access.

Due to increased standardization in the IRS market, the market was primed for exchange-style trading by 2007, when a trading platform known as Tradeweb became available, the complaint states. KCMERS alleges that defendants addressed the competitive threat by collectively taking control of a majority of Tradeweb's board seats in order to control what features it offered and to facilitate informal meetings between the defendants to coordinate efforts to prevent competitive exchange-type platforms from gaining traction.

Plaintiff alleges that defendants also engaged in collusive conduct to thwart potential exchange trading competition from the Chicago Mercantile Exchange (CME) and LCH.Clearnet. Defendants' conduct was characterized as a pattern of systematic group boycotts and other anticompetitive activity which resulted in investigations by the Department of Justice (DOJ) and the European Commission (EC), the complaint states.

Despite the recognition that derivatives were an important contributing factor to the 2008 financial crisis, and Congressional efforts to increase transparency in the IRS market, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, defendants have continued to block any meaningful change to the status quo, the complaint alleges. By 2013, after Dodd-Frank was enacted, the complaint alleges, the defendants continued to conspire to preserve the status quo by engaging in direct threats and retaliation to deter buy-side entities from making markets on exchange-like platforms known as swap execution facilities (SEFs).

The complaint alleges that the defendants implemented their conspiracy through private meeting among themselves, by highly confidential collective projects protected by non-disclosure agreements, by retaliation against market participants that threatened the status quo, and by fraudulent concealment of all of the above. The two-count complaint alleges a conspiracy to restrain trade in violation of Section 1 of the Sherman Act and unjust enrichment, and seeks treble damages, injunctive relief, and the costs of lawsuit including attorneys' fees.

The case is No. 1:16-cv-04005.

Attorneys: Blair A. Nicholas (Bernstein Litowitz Berger & Grossmann LLP) and Scott Allan Martin (Hausfeld LLP) for Kansas City, Missouri Employees' Retirement System.

Companies: Bank of America; Barclays; BNP Paribas; Citi; Credit Suisse AG; Deutsche Bank; Goldman Sachs; HSBC; ICAP Capital Markets; J.P. Morgan Chase; Morgan Stanley; Royal Bank of Scotland; Tradeweb Markets; UBS

News: Antitrust NewYorkNews