Antitrust Law Daily Wrap Up, ANTITRUST NEWS: Investment company alleges major banks have monopolized credit default swap market, (Jul 30, 2013)

By Tobias J. Gillett, J.D., LL.M.

A German investment company has filed a putative class action complaint in the federal district court in Chicago, claiming that major bank dealers have conspired to control the market for trading in credit default swaps (CDS) in violation of federal antitrust law (LBBW Asset Management InvestmentgesellschaftmbH v. Citibank, N.A., filed July 29, 2013).

A credit default swap (CDS) is a financial derivative contract in which the buyer pays the seller in exchange for the seller’s promise to make the buyer whole in an agreed amount in the event of some “credit event,” such as bankruptcy, by a third party. The CDS market permits participants to speculate on a view of anticipated credit deterioration or appreciation. In the CDS market, buy-side participants indicate interest in specific CDS to dealers, and dealers quote bids to customers wishing to sell and asks to customers wishing to buy. CDS dealers profit by buying CDS protection at a lower price than they will sell the same protection, known as the “bid/ask spread.” The greater the spread, the more profits dealers can earn on transactions.

According to the complaint, the defendant dealers accounted for more than 95% of the amount of CDS purchases and sales between January 1, 2008 and December 31, 2011. Defendants JPMorgan and Citigroup are estimated to hold 60% of the CDS market, with Bank of America holding another 15% of the market. Through their alleged anticompetitive conduct, the dealers have ensured that a dealer bank has been on at least one side of every CDS transaction.

The Determination Committees of the International Swaps and Derivatives Association (ISDA) wields “immense power” over the CDS market by deciding, at the request of filers, whether an event of default (EOD), succession, or restructuring has occurred, according to the complaint. The dealers “dominate the leadership” of the ISDA through occupying seats on its board of directors. The Committees have allegedly been subject to frequent criticism for providing the dealer defendants who are voting members of the Committees with “the opportunity to create credit event outcomes favorable to their own trading position and exposure.”

To reduce risk and promote stability in the CDS market, CDS transactions are cleared through clearinghouses. Clearinghouses, backed by a network of cross-guaranties among the member firms, are substituted for the buyer and seller in a CDS transaction, ensuring that the buyer of a CDS contract is not at risk for a failure to perform by its counterparty.

In 2008, the hedge fund Citadel Group and the Chicago Mercantile Exchange (CME) proposed creating an electronic exchange for CDS, known as CMDX, a move that would have bypassed the dealer defendants as intermediaries. The dealer defendants allegedly responded by partnering with ICE Clear Credit LLC, a rival clearinghouse, but attaching conditions to the partnership that gave the dealers significant control over ICE.

The dealers control ICE through seats on its board of directors and on its Risk Committee. The Risk Committee established allegedly unnecessary and prohibitively high capital requirements for potential members to join ICE, initially requiring that potential members have net capital of $5 billion in their derivatives unit. This limit effectively excluded buy-side participation through ICE, and ensured that a dealer remained on at least one side of every transaction. In July 2011, in response to potential action from the Commodity Futures Trading Commission, ICE reduced its capital requirements to $100 million, but required broker-dealers or future commission merchants to hold 5% of customer funds as excess net capital, allegedly effectively preventing smaller entities from entering the CDS clearing market. In May 2012, to comply with new CFTC regulations, ICE reduced the capital requirement to $50 million, and dropped the customer funds retention requirement.

The dealers also allegedly exercised their control over the ISDA and Markit Group Ltd. to deny CMDX licenses needed to operate an exchange. The dealers control Markit Group, the only provider of real-time CDS market data, through seats on its board of directors. Markit Group insisted that every CDS trade involve at least one of the dealers, a requirement CME and Citadel were forced to agree to in order to obtain Markit’s license, resulting in CMDX’s restructuring as a clearing-only service rather than an exchange. The dealers then “unreasonably delayed” providing licenses from the ISDA and Markit Group, permitting ICE to launch before CMDX. ICE now clears the “vast majority” of CDS transactions. The dealers sidelined CMDX by becoming members of it and exerting a degree of control over it, and by directing nearly all of the CDS they cleared through ICE. By suppressing competition from CMDX and other nascent exchanges, and eliminating the threat of exchange trading, the dealers allegedly maintained their central role in the CDS market.

The dealers’ control over the market, over real-time pricing information through Markit Group, and over the ICE clearinghouse presents significant barriers to entry into the CDS market, the complaint asserts. The dealers allegedly facilitated their anticompetitive conduct through communications occurring “(a) when establishing ICE Clear; (b) during ICE Clear Risk Committee Meetings; (c) during discussions concerning or relating to Markit Group’s pricing data in CDS clearinghouses; (d) when distributing revenue generated by ICE Clear; (e) when attending ISDA meetings; and (f) during their jointly organized lobbying of the SEC, CFTC and Congress.”

The complaint notes that the Department of Justice Antitrust Division and the European Commission have opened antitrust investigations into the CDS market.

The complaint asserts that the dealer defendants violated Section 1 of the Sherman Act and Section 4 of the Clayton Act by conspiring to maintain or stabilize CDS spreads and violated Section 2 of the Sherman Act by conspiring to monopolize the CDS market. The complaint also asserts a claim for unjust enrichment and restitution/disgorgement.

The complaint seeks treble damages under the federal antitrust laws, damages for unjust enrichment, costs of suit, attorneys’ fees, and any other just and proper relief.

The case is No. 1:13-cv-05413.

Attorneys: Marvin A. Miller (Miller Law LLC) for LBBW Asset Management InvestmentgesellschaftmbH.

Companies: Citibank, N.A.; Citigroup Inc.; Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Credit Suisse Group AG; Deutsche Bank AG; Morgan Stanley Bank, N.A.; Barclays Bank plc; Bank of America Corp.; HSBC Holdings plc; Royal Bank of Scotland Group plc; BNP Paribas S.A.; UBS AG; Wells Fargo Bank & Co.;Markit Group Ltd.; International Swaps and Derivatives Association; LBBW Asset Management InvestmentgesellschaftmbH

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