U.S. Justice Department investigates credit default swaps

July 14, 2009

NEW YORK, July 14 (Reuters) – Markit Ltd, a dealer-owned provider of prices in the credit default swap market, said on Tuesday the U.S. Justice Department is investigating the $26.5 trillion market.

“Markit has been informed of an investigation by the Department of Justice into the credit derivatives and related markets,” the company said in a statement, but it did not specify the targets of the investigation.

“Markit strives to enhance the transparency and efficiency in the credit derivatives market by making all our independent data products commercially available to all market participants,” the statement added.

The Justice Department’s Antitrust Division this month sent civil investigative demands to some large dealers in the CDS market, seeking detailed information about their CDS exposures and their relationship to Markit, said people familiar with the letters.

The Justice Department is thought to be looking into whether dealers that have an equity stake in Markit have any unfair advantage over other market participants relating to CDS price information, analysts said.

A spokeswoman for the U.S. Justice Department’s Antitrust Division declined comment.

CDSs are privately traded contracts used to insure against a borrower defaulting on debt or to speculate on their credit quality.

Markit, which describes itself on its Website as “the benchmark for CDS pricing data,” collates CDS prices from dealers, and disseminates intraday and end-of-day prices to subscribers of the service. Some end-of-day prices are also made available on the company’s Website for free.

Thomson Reuters buys and disseminates Markit’s CDS prices.

JPMorgan is the largest single holder of Markit’s shares, according to an annual return filed on U.K. Companies House in May this year.

Other banks with large share holdings include Bank of America, Goldman Sachs, Royal Bank of Scotland Group, Citigroup , UBS and HSBC Bank, the filing shows.

Markit owns the benchmark credit derivative indexes in the United States and Europe.

The company was also a driving force behind recent changes to standardize CDSs contracts, which were overhauled in a bid to make them easier to enter into central clearinghouses.

Central clearing of CDSs is a key plank of the Obama administration’s efforts to remove risks and enhance transparency in the market.

The government is also encouraging some CDS contracts to be traded on exchanges or other electronic platforms, a move that threatens to reduce the margins banks charge for trades.

“I do see an evolution toward electronic trading of these products on an exchange-like platform, and this could be another step in that evolution,” said Chris Allan, analyst at broker-dealer Pali Capital in New York.

This “has always been a sticky point for the dealers. The more transparency you have out there the tighter the spreads become,” he said.

Critics say that the lack of transparency in the unregulated market also makes it ripe for manipulation.

Regulators have been probing the CDS market for evidence of potential price manipulation, which they believe could have enhanced worries about financial companies and contributed to the failure of companies including Lehman Brothers.

The U.S. Securities and Exchange Commission last year sent subpoenas to interdealer credit derivative brokers relating to the trading of CDSs on financial companies in September 2008.

The move followed a request from New York Attorney General Andrew Cuomo that also related to the trading of financial CDS in September, the month that Lehman failed. For details see. (Reporting by Karen Brettell; Additional reporting by Jonathan Spicer in New York, Jane Baird and Natalie Harrison in London, and James Vicini in Washington; Editing by James Dalgleish)

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