EC presses charges on CDS collusion

* EC follows 2-year investigation on banks, Markit & ISDA

* CDS liquidity shifts to dealer-led trading platforms

By Helen Bartholomew

LONDON, July 1 (IFR) - The European Commission has charged13 banks as well as ISDA and Markit for breaching antitrustrules by blocking exchanges from entering the credit defaultswap business between 2006 and 2009.

Whether by collusion - as the EC alleges - or not, dealersinvolved in the US$27trn over-the-counter market, down from apeak of US$58trn in late 2007, proved successful in keeping theinstruments off exchanges, despite a number of attempts tocreate listed alternatives as volumes ballooned in the run up tothe crisis.

That is set to change with a sweeping structural shiftcurrently underway via Dodd-Frank in the US and EMIR in Europe,which pushes all standardised OTC derivatives through centralclearing and ultimately across electronic platforms.

But this time around, banks might not lose out from theshift altogether. Early signs from the first waves of theDodd-Frank clearing mandate are that the eventual winners arelikely to be those platforms that have strong dealer backing.

The EC charges follow a two-year investigation into a rangebanks that was extended to the industry body earlier this year.Statements of objection have been sent by the Commission to Bankof America Merrill Lynch, Barclays, Bear Stearns, BNP Paribas,Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley, Royal Bank of Scotland, and UBS, as wellas to ISDA and Markit.

The EC claims that market participants colluded to licensethe products only for over-the-counter trading in an effort forinvestment banks to maintain the high revenues that they hadbeen generating.

"It would be unacceptable if banks collectively blockedexchanges to protect their revenues from over-the-countertrading of credit derivatives," said Joaquin Almunia, Commissionvice president in charge of competition policy at the EC, in awritten statement.

"Over-the-counter trading is not only more expensive forinvestors than exchange trading, it is also prone to systemicrisks."

FAILED EXCHANGE ALTERNATIVES

Exchanges made significant efforts to get in on the act asthe OTC market for such credit instruments doubled in grossnotional terms during both 2006 and 2007, according to figuresfrom the Bank for International Settlements.

But those efforts were in vain, as both Germany's Eurex andLondon's LIFFE failed to drum up support for their tradableversions of the instruments, after struggling to attract thesell-side support necessary to achieve the critical mass anddeliver the cost savings typically associated with liquid,exchange-traded products.

Eurex launched its credit futures contract linked to iTraxxEurope Main in March 2007, while the LIFFE derivatives exchangemade its own botched attempt with a listed CDS contract in July2008.

In August 2009, in the wake of the financial crisis andfollowing the G20 agreement that sought to shift OTC productsthrough central counterparty clearing, Eurex began clearingindex CDS and became the first CCP to clear a single-name creditdefault swap later that year.

Once again, it struggled to drum up support and the servicehas since been taken offline. But where it failed on theclearing attempt, one rival firm now appears to finally bemaking headway.

The IntercontinentalExchange - a dealer-backed platformwhose top shareholders include Goldman Sachs, JP Morgan andWells Fargo - has cleared more than US$30trn of gross notionalin credit default swaps since it began offering the service inMarch 2009.

Those successes have led the exchange to list a new creditfutures product tracking CDX Investment Grade, CDX High Yield,iTraxx Main and iTraxx Crossover indices.

A competing product is currently being prepared by start-upelectronic platform TrueEx, which plans to offer contractslinked to S&P Dow Jones indices that reference the top 120issuers in the S&P 500 (see IFR 1989 "Swaps to futures migrationshifts to credit").

ICE isn't the only dealer-backed firm making waves. Afterfinding success with its interdealer electronic platform fortrading US CDS contracts, Tradeweb (in which IFR's owner ThomsonReuters owns a stake) enhanced its European platform earlierthis year, driving an associated 50% increase in iTraxx Main andCrossover trading volumes (see IFR 1975 p6 "Tradewebrevolutionises CDS") as liquidity almost instantaneouslymigrated to the platform. (Reporting by Helen Bartholomew; editing by Alex Chambers,Julian Baker)