August 02, 2013
Derivatives: Learning to love anti-competitive behavior?
Posted by Erik Gerding

Of course no one loves price fixing - other than those in on the fix.  

Indeed, allegations of anti-competitive behavior in OTC derivatives markets have recently surfaced on both sides of the Atlantic.  This week MF Global brought a class-action antitrust suit in the Northern District of Illinois against a number of large financial conglomerates and ISDA alleging violations of the Sherman Act.  MF Global claims that the defendants conspired to deny derivatives brokers access to central clearing (by restricting access to a platform called ICE Clear controlled by the dealers).

MF Global's lawsuit builds on a European Union investigation involving similar allegations against many of the same defendants.  The gravamen of the E.U. investigation: firms colluded to block Deutsche Boerse and the Chicago Merchantile Exchange from creating electronic exchanges for the credit derivatives market.

But one question lurking not too far below the surface is what this alleged behavior might mean for systemic risk.

On the one hand, there is a broad trend among policymakers in many nations to move OTC derivatives to exchanges and central clearing.  The theory is that transparent exchange pricing and centralizing counterparty risk is a good way to mitigate systemic risk.  (This view, however, is not universally shared; some see the move to centralize counterparty risk as transforming clearing houses into potential systemic risk time bombs.  For a nuanced analysis - click here).

So what else is not to love about opening up exchange trading and central clearing of derivatives to all?

Fighting systemic risk and ensuring price competition in derivatives markets are somewhat awkward bedfellows.  Drilling a little deeper into the MF Global complaint, it appears that the crux of the allegations is that the smaller fish derivatives brokers could not clear trades on ICE Clear directly, but were forced to do so through one of the larger brokers that are members of ICE Clear.  The big conglomerates allegedly restricted membership in the clearinghouse that they helped set up.  The clearinghouse allegedly served as a kind of club to protect conglomerate profits in dealing derivatives.

Here is where things get tricky.  If you believe that the crisis was exacerbated by too many credit derivatives being sold too cheaply (something I've written about), then perhaps anti-competitive behavior has some potential (and I stress both of those last two words) silver linings.  After all, oligopoly behavior typically leads to too few of products being sold at prices that are too high.

This is not to condone any anti-competitive behavior.  It is merely to underscore a somewhat uncomfortable fact: promoting financial stability and promoting vigorous price competition in financial markets can sometimes be in tension (something Gary Gorton has written about).  The relatively stable and boring world of banking that imploded in the 1970s and 1980s was not vigorously competitive.  In fact, it was competition from money market mutual funds and various other capital market products that blew open the doors to competition and started the cycle of financial deregulation spinning.


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