U.S. regulators are examining whether banks colluded in setting prices in the derivatives market where investors speculate on credit risk, according to a person with knowledge of the matter.
The U.S. Securities and Exchange Commission is probing whether firms acted in unison to distort prices in the $6 trillion market for credit-default swaps indexes, said the person, who asked not to be identified because the investigation is private. The regulator is trying to determine if dealers have misrepresented index prices, the person said. The credit-default swaps benchmarks allow investors to make bets on the likelihood of default by companies, countries or securities backed by mortgages.
Judy Burns, an SEC spokeswoman, declined to comment.
The probe comes after successful cases brought against Wall Street’s illegal practices tied to interest rates and foreign currencies. Those cases showed traders misrepresented prices and coordinated their positions to push valuations in their favor, often through chat rooms — practices that violate antitrust laws. The government has used those prosecutions as a road map to pursue similar conduct in different markets.
Credit-default swaps, which gained notoriety during the financial crisis for amplifying losses and spreading risks from the U.S. housing bust across the globe, have since come under more scrutiny by regulators. Trading in swaps index contracts has increased in recent years as investors look for easy ways to speculate on, say, the health of U.S. companies, or the risk that defaults will increase as seven years of easy-money policies come to an end.
Toward the end of each trading day, benchmark prices for indexes are tabulated by third-party providers based on dealer quotes, creating a level at which traders can mark their positions. This process is similar to how other markets that don’t trade on exchanges set benchmark prices. That includes the London interbank offered rate, an interest-rate benchmark. In the Libor scandal, regulators accused banks of making submissions on borrowing rates that benefited their trading positions.
A group of Wall Street’s biggest banks have traditionally dominated trading in the credit swaps, acting as market makers to hedge funds, insurance companies and other institutional investors. Those dealers send quotes to clients over e-mails or on electronic screens showing at which price they will buy or sell default insurance. Those values rise and fall as the perception of credit risk changes.
Since the crisis, new regulation has required much of the trading to be done on electronic platforms with clearinghouses backing those transactions in an effort to increase transparency and reduce counterparty risk. Those moves have also diminished the banks’ role in the market.
The SEC is looking at both actively traded and less-liquid index contracts, the person said.
Bloomberg LP, the parent of Bloomberg News, offers trading of credit swaps and indexes between banks and customers.
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