Do dealers have a chokehold on CDS markets?

European competition regulators are examining the coordinated activities of the big dealer banks in the credit derivatives space – a pretty dark part of financial markets. Supposedly, the dealer banks are thwarting competition for these products by using groups like Markit and ISDA (a trade association) to block access for other venues to conduct trading in credit default swaps. Markit’s board of directors includes employees of Bank of America, BNP Paribas, Commerzbank AG, Goldman Sachs, HSBC, JP Morgan and Morgan Stanley, and it has been under investigation by the U.S. Department of Justice since 2009. Bloomberg reports:

Regulators found ‘indications that ISDA may have been involved in a coordinated effort of investment banks to delay or prevent exchanges from entering the credit derivatives business,’ the European Commission said in a statement today. The EU started a probe in April 2011 into whether 16 lenders, including Citigroup Inc. and Deutsche Bank AG, colluded by giving pricing information to data provider Markit Group Ltd.

The EU’s probes add to separate antitrust investigations into whether banks colluded to manipulate benchmark lending rates, including the London interbank offered rate. The U.S. Justice Department is also probing the credit derivatives clearing, trading and information services industries.

I don’t have any particular knowledge of those facts, but I did write last year about how ISDA and Markit were working together to push the use of credit default swaps in the municipal space. From MuniLand last April:

The use of credit default swaps in muniland is poised to take off, a project that’s being called the ‘U.S. Municipal CDS Bang.’ Starting Apr. 3, the terms and conditions of new muni CDS have been standardized with the stated intent of creating a useful risk-hedging product. This project is being driven not by regulators but by Markit, a private market-data vendor, and the International Swaps and Derivatives Association, a global consortium of Wall Street banks. But it’s not so clear that this is what the market needs at this time.

CDS in muniland – There is no “there” there


Kamakura Corporation, a risk management firm in Honolulu, Hawaii, has updated their analysis of the volume of trading in municipal credit default swaps (CDS). Here is what they say:

On January 11, 2012, we looked at weekly credit default swap trading volume for subsovereigns and municipals among 1,090 90 reference names that had traded in the 77 weeks ended December 30, 2011.  We found, unfortunately, that (in the words of Gertrude Stein) “there is no there there.” In this blog,  we update our CDS volume analysis for subsovereigns and municipals for the 103 weeks ended June 29, 2012. Alas, our conclusion is unchanged.

Kamakura documents that there is very little volume in muni CDS trading, and most of it is done between dealers. Essentially it’s an artificial market with very few trades outside the dealer community.  Kamakura, in their analysis, strips away the trades that dealers are doing between themselves:

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