Financial market participants have claimed in recent suits that securities dealers and prime brokers active in certain financial markets have engaged in coordinated actions to suppress the introduction of more efficient trading platforms. These trading platforms represent competition to existing over-the-counter trading markets dominated by incumbent dealers and prime brokers. From a competition policy perspective, the alleged collusive conduct represents a violation of antitrust laws to the detriment of customers. More broadly, the alleged conduct runs counter to important regulatory reforms aimed at making financial markets safer, more transparent, and more efficient in the aftermath of the 2008 Financial Crisis.
Recent regulatory reforms have been introduced to increase the efficiency and stability of financial markets. The Financial Crisis Inquiry Commission (“FCIC”) found that the lack of transparency and a lack of capital and collateral requirements in over-the-counter derivatives markets contributed to the 2008 financial crisis in significant ways. In the markets for interest rate and other swaps, for example, the FCIC found that the absence of centralized exchanges both suppressed price discovery and increased counterparty risk for market participants. In the aftermath of the 2008 Financial Crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) aimed at reforming the U.S. financial system. Among other reforms, Dodd-Frank laid the foundation for changes in trading execution for swaps that would enhance pre-trading and post-trading pricing transparency to improve price discovery, and mandated centralized clearing to guarantee the performance of contracts, thereby reducing risk.
These changes are significant because the organization and structure of financial markets determine their efficiency. For example, exchange-based all-to-all trading and centralized clearing improve liquidity, transparency, price-discovery, and risk management because investors receive quotes from multiple sources and face less counterparty risk. Over-the-counter trading, in contrast, is based on intermediated bilateral transactions with limited access to information, which usually makes markets less efficient than if there are quotes from multiple sources.
Two recent suits allege that dealer banks colluded to prevent the introduction of trading platforms that would have competed with over-the-counter trading. On June 8, 2017, Tera Group filed a complaint against the twelve largest credit default swap dealers in the United States (Tera Group, Inc. et al v. Citigroup, Inc. et al, SDNY, 1:17-cv-04302) for allegedly coordinating to exclude the TeraExchange electronic trading platform from the $9.9 trillion (notional value) credit default swap market. Similarly, on August 16, 2017, certain public employee pension funds filed a class-action lawsuit against Bank of America and other large financial institutions (Iowa Public Employees’ Retirement System et al. v. Bank of America Corporation et al., SDNY, No. 17 Civ. 6221). Plaintiffs in this suit claim that defendants boycotted new trading platforms that were trying to enter the $2 trillion stock lending market and offer all-to-all trading platforms.
Certain markets, including the credit default swap and the stock lending markets, are characterized by a two-tier structure. On one tier, customers access the market via intermediaries (dealers or brokers) and are prohibited from trading directly with other customers. Intermediaries, on the other hand, typically transact directly with each other (as well as with customers) on electronic interdealer trading platforms. Historically, intermediation in this way was justified as a means to lower search costs and by dealers’ expertise in risk analysis. In practice, however, electronic trading and the wide availability of risk analysis tools have lowered the need for strictly intermediated transactions. Plaintiffs allege that intermediaries favor inefficient, opaque over-the-counter trading to take advantage of superior price information and charge their customers (hedge funds and pension funds) inflated bid/ask spreads. Lack of transparency and liquidity results in a greater gap between the price buyers pay and the price sellers receive. Pre-trade price transparency would inform customers of market opportunities based on available bid and ask quotes. According to the Tera Group plaintiffs, defendant dealer banks’ role as market makers accounted for 95 percent of the credit-default swap market, and such collective dominance allowed these banks to structure the market in two tiers to the detriment of customers (institutional investors). Similarly, the public employee pension fund plaintiffs allege that defendant prime brokers’ dominance of the stock lending market allowed them to structure trades through intermediaries and generate large fees.
Plaintiffs identify a number of new entrants offering improvements in execution, price discovery, and risk management through all-to-all trading, pre-trade and post-trade price dissemination, and centralized clearing. Plaintiffs allege that defendants organized collective responses to starve these new entrants of liquidity through a group boycott and by leveraging their power over hedge funds and pension funds that depend on a variety of services dealers provide them to preempt them from trading on these platforms. Plaintiffs allege that defendants threatened not to provide their clients these services if they participated in the competing trading platforms.
Plaintiffs claim that the defendant banks’ alleged misconduct violated Section 1 of the Sherman Act. Other recent lawsuits and decisions concerning large banks and collusive conduct since the 2008 Financial Crisis have focused on bid rigging in the municipal bond market, LIBOR manipulation, foreign exchange spot market price and benchmark rate manipulation, and interest rate swaps benchmark rate manipulation. These more recent claims involve alleged conduct in other securities markets. To the extent these claims are true, the alleged collusive behavior would undermine competition-based market changes towards more efficient and safer financial markets.