The nation's top antitrust cop urged regulators to stiffen derivatives trading rules -- or risk having giant banks join up to make a mockery of financial reform.
The Justice Department said Tuesday that rulemaking proposals floated this fall by the Securities and Exchange Commission and the Commodity Futures Trading Commission "may not sufficiently protect and promote competition in the industry."
Justice took issue with how the SEC and CFTC would restrict Wall Street ownership of the clearinghouses that will be used to settle derivatives trades, bets tied to the values of financial assets and market indexes.
Derivatives markets have become a major profit driver at dealers such as JPMorgan Chase (JPM), Goldman Sachs (GS) and Deutsche Bank (DB), and the five biggest U.S. banks control 97% of a domestic market whose notional value is estimated at $234 trillion. The global market is, of course, at least twice as big. Reducing the risk of a big blowup there was a major focus of the Dodd Frank Act adopted this summer.
But the Justice Department said regulators' failure to set an explicit limit on the big dealers' aggregate ownership of clearinghouse stakes could leave the SEC and CFTC far short of their stated goal of preventing the biggest banks from ganging up and driving trading prices higher.
The Justice statement compared derivatives trading platforms to airports and warned what hell might break loose without limits on who owns what.
Limiting aggregate ownership and imposing stringent governance requirements … may prevent the emergence of a dominant trading platform controlled by major dealers to the detriment of other market participants. The creation of such a platform would be roughly analogous to the three or five largest airlines controlling all landing rights at every U.S. airport-the big carriers could use this control to disadvantage smaller carriers by restricting landing rights or raising their rivals' costs to access the airports.
Most derivatives trading now takes place over the counter, in contracts negotiated among the big dealer banks and with their customers.
The Dodd Frank Act seeks to push most derivatives trades into regulated clearinghouses or exchanges in an attempt to boost market transparency and reduce so-called counterparty risk -- the fear, seen most recently in the 2008 collapse of Lehman Brothers -- that one's trading partner will fail to make good on its obligations.
Though the SEC and CFTC offered two proposals for restricting individual ownership of the clearinghouses – mutual organizations in which other members absorb the costs if one fails – the Justice Department warns that without aggregate position limits, those proposals could prove ineffective.
In the Department's view, however, it is not sufficient to impose restrictions only on individual ownership or control; an aggregate cap on ownership or control by participants and members also should be required. This is because the major dealers as a group likely share very similar incentives to limit access and to otherwise insulate themselves from competition. Accordingly, while the cap on individual ownership will eliminate the chance that a single entity could gain direct control over a [clearinghouse] to the detriment of competition, under the SEC's proposal, there is no barrier to a group of entities -- major derivatives dealers, for example -- working together to control a [clearinghouse] to their combined competitive advantage.
Because billions of dollars in trading-related profits are at stake, both the banks and their opponents have shown a zeal for lobbying both legislators and agency rulemakers.
Michael Greenberger, a University of Maryland law professor who has been calling for regulators to clean up the derivatives markets, said the Justice Department statement will send a strong signal to the SEC and the CFTC, which he said have been less than decisive in cracking down on Wall Street overreach.
"This is a very important step when the expert on anticompetitive behavior makes such a powerful set of comments," he said. "This is going to be very influential on the courts and on the commissions."
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