Banks may not like being the object of regulatory finger-pointing, but markets likely do just fine. Photo by Hulton Archive/Getty Images.
Some of the world’s biggest banks are under fire from regulators again—this time over allegedly colluding to limit competition in credit derivatives markets. Regulatory action always bears watching, and regulatory overreach is one of today’s less frequently discussed risks. However, this latest development likely doesn’t much impact global markets.
At issue is the European Commission’s preliminary ruling that 13 investment banks, the International Swaps and Derivatives Association (ISDA) and data provider Markit deliberately shut Deutsche Börse (DB) and the Chicago Mercantile Exchange (CME) out of credit derivatives markets between 2006 and 2009. During that time, credit default swaps (CDS) and other credit derivatives were traded only over the counter (OTC). According to the Commission, DB and CME applied to ISDA and Markit to establish and license data for credit derivatives exchange platforms, but they received licenses only for OTC trading. According to the Commission’s findings, the banks goaded ISDA and Markit to “collectively shut out the exchanges from the market because they feared that exchange trading would have reduced their revenues from acting as intermediaries in the OTC market.”
Whether or not this is true—and whether or not the preliminary ruling stands—there are likely few (if any) forward-looking implications for global stocks or credit markets. For one, it likely shocks no one that banks would try to protect profits—and preserve the OTC mechanism in order to do so. Nor would many folks be surprised to learn the ISDA—a trade association—would look out for the interests of its many member banks.
And IF this did happen, it didn’t necessarily come at the expense of financial stability, contrary to what some observers speculate. Much of Monday’s commentary referenced the role credit derivatives played when Lehman Brothers failed in 2008, suggesting collusion to keep CDSs off exchanges exacerbated the crisis. But this ignores the fact credit derivatives markets functioned seamlessly when Greece’s early 2012 default triggered CDSs, even though the architecture and market makers then were largely the same as in 2008. Trying to pin blame retroactively is simply a misguided adventure—not to mention very backward-looking.
For markets, what’s more important is the Commission’s actions shouldn’t increase the risk of further regulatory changes. Dodd-Frank and various EU regulatory initiatives have largely headed off any rule changes the Commission’s ruling would have prompted—credit derivatives are already moving from OTC to formal exchanges (with a few exceptions). This addresses many of the issues the Commission highlighted, including market transparency. It should also promote CDS liquidity and more efficient price discovery—noteworthy positives.
Financials themselves, however, may feel some pressure—investigations like this can give investors headaches in the near term, and this isn’t the only inquiry in progress. The Commission’s also investigating alleged rigging of Japanese interbank lending rates and the Swiss franc, Korean regulators are looking into collusion on CD rates, and the LIBOR fixing probe continues. And if the Commission rules against the banks, guilty parties could be fined up to 10% of annual revenues, which likely dings earnings a bit.
At the same time, these and other investigations are long-known events, and the banks involved have had ample time to digest the likelihood of guilty verdicts and earmark funds accordingly. Hence, these potential liabilities needn’t take a big bite out of bank lending looking ahead. Plus, with yield curves globally starting to steepen some, there’s fundamental support for loan growth even if banks need to pay the piper a bit more than expected, which should further mitigate potential macroeconomic impact.