Banks Preferred Profitable CDS Business Over Less Profitable One

The thing about antitrust law is that it's so understandable. Not in the sense that a human can easily understand antitrust law, particularly, just that it's easy to understand where the people who violate it are coming from.1 This EU antitrust case against 13 banks for "colluding to prevent the lucrative global business of trading credit derivatives from moving onto regulated exchanges and away from markets controlled by the banks themselves," for instance. Like, here you are in 2006 or whatever, and you're a big bank, and you've built yourself a nice little business buying and selling credit default swaps. This generates information and that information is useful; it's even more useful if you share it with your other CDS-trading friends. So you and your big-bank friends and your ISDA and your Markit get together to share trade data, just like those guys did under that buttonwood tree that one time. Once you've got trade data, for instance, you can make an index, and so you can trade index CDS, which means you can move from having a weird niche product to a macro credit product, and it is good. Also you can gouge customers because, y'know, it's OTC and stuff.

Anyway one day an exchange comes to you and says "we'd like to take all your data and use it to massively undercut you on price and drive you out of this lucrative little business you got here, whaddaya say?" And so obviously you say no. The EU thinks that's an antitrust violation and I guess it is but you can see where they were coming from? Like, that's pretty harsh: you build a business and just when it's successful, not only does someone come along to cannibalize it, but you have to help them do it. "Here, take our data, put us out of business, really, we don't mind."2

While the banks' resistance to change is understandable it also seems a little hopeless. Because there's antitrust law, for one thing, but also, like, come on. Financial products move over time toward transparency, standardization, tradeability. Now you can buy CDS futures. In any particular day or month or year people are pretty conservative about what new things they'll do, what venues they'll trade on, and what products they'll use as substitutes for other products, but eventually faster and better and cheaper really should beat high-priced non-transparent monopolistic voice trading.3 Maybe even for bonds, who knows.

In general you'd expect this to play out in the form of low-grade bickering between the banks and exchanges, not a big EU investigation, but of course the banks' delaying tactics took place just before a global financial crisis in which bilateral OTC credit derivatives played a starring role, so, bad timing.4 "If, after the parties have exercised their rights of defence, the Commission concludes that there is sufficient evidence of an infringement, it can issue a decision prohibiting the conduct and impose a fine of up to 10% of a company's annual worldwide turnover," though you could imagine that paying 10% of one year's revenue for a, like, five-year delay in credit derivatives' move to exchange-type business might actually be an attractive proposition even in hindsight. Depending on how you did on your credit derivatives in '07-'08. Not attractive for Lehman obviously.

Incidentally if you're building yourself a derivatives business in the shadow of increasing electronification and exchangification and antitrust enforcement, how do you, like, moat it up? Well, popular products that are useful to a lot of customers in a lot of situations seem like the ones most likely to move to exchanges. Those tend to be products that solve economic problems: hedging macro credit risk and stuff. Contracts built to solve regulatory problems, on the other hand, are more likely to be one-off. And customized. And the sort of thing that the client isn't really looking to publicize. You won't see Renaissance's basket option contract listed on the CME any time soon. Which makes it a good business. Though I guess it's illegal too.

Antitrust: Commission sends statement of objections to 13 investment banks, ISDA and Markit in credit default swaps investigation [EU]
EU Charges Banks Over Derivatives Trading [WSJ]

1.I mean, I guess you can understand why people, like, steal a briefcase full of $100 bills from an airplane too, but you know what I mean.

2.Obvs I'm being melodramatic, banks don't go out of business when an OTC product moves on to an exchange. Actually there's anecdotal evidence that they sometimes do better - what they lose on margins they make up in volume. Still.

3.Also I'll just never understand indices, and the licensing of indices. Like, CME or Deutsche Börse: set up your CDS market. Don't license data feeds from Markit. Let people trade. If there's an arb between OTC and exchange, someone will arb it. Your prices will be fine. Once your prices are fine, set up your own index from your own data. I know this wouldn't really work but it sort of bothers me that it wouldn't. WHERE ARE YOUR EFFICIENT MARKETS?

Also, obviously there's the irony of the CME suing to stop other exchanges from using its licensed index data to trade products that compete with it, while also being the antitrust whiner here because it couldn't use the banks' index data to trade products that competed with the banks, but, whatever, I can't really hold it against them. You say "hypocrisy," I'll say "smart business practices."

4.E.g.:

The Lehman bankruptcy "has shown how this mechanism of over-the-counter negotiations of derivatives, and in particular credit default swaps, is capable of destabilizing the entire financial system," EU antitrust chief Joaquín Almunia said Monday.

"[The banks] delayed the emergence of exchange trading of these financial products because they feared it would reduce their revenues," Mr. Almunia said.