July 14, 2009 / 1:51 PM / 11 years ago

U.S. Justice Dept investigates CDS pricing

LONDON (Reuters) - The U.S. Justice Department is investigating whether the banks that own Markit, a leading information supplier in the credit default swaps market, have unfair access to price information, Bloomberg reported, citing three people familiar with the matter.

“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.

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

CDS are over-the-counter bets on whether a company will default on its debt within a fixed period of time. One counterparty to the CDS contract buys protection against default from the other.

CDS dealers are under pressure from regulators on both sides of the Atlantic to use central clearing houses as a way to reduce counterparty risk.

“This might be another push by regulators to obtain a clearing house for derivatives. That may be the end game in all of this,” said Gary Jenkins, head of fixed income research at Evolution Securities.

“Maybe they have uncovered something, but I’m not sure how. Although Markit owns the indices, it is not a market maker,” he added.

Markit, based in London and owned by major banks, provides services such as the benchmark indexes, real time and end-of-day prices and trade processing for more than 1,000 financial institutions including banks, asset managers, rating agencies, central banks, hedge funds and regulators.

“Markit has a very good reputation and is involved in so many crucial things that if this is true (that banks have unfair access to pricing), it would shake the confidence in the CDS market,” said a manager of a German credit fund.

He cited as an example the firm’s central role in conducting auctions to settle CDS contracts following defaults.

The investor said, however, that he figured “the highest probability is that this is a non-event,” part of a review of the CDS market as a whole.

A CDS trader also was skeptical that any investigation would find that Markit’s owners get access to privileged information.

“If you are one of the top 10 investment banks, you will know what CDS pricing and trading patterns are,” he said. “You are not going to be getting anything out of Markit that you don’t know already.”

A trader at a big CDS dealer said: “Their (Markit) prices are far behind my price quality. It’s just that no one pays me the money that we pay Markit.”

One source who plays a central role in the derivatives market speculated that the investigation may stem from the fact that the pricing which banks supply to Markit can differ from what they have on their own books, particularly for illiquid securities.

The volatility in the CDS market combined with understaffing in banks means that prices sent to Markit may not be updated in an absence of trades, even while the bank’s dealers can produce timely pricing, he said.

With reporting by Jane Baird and Natalie Harrison in London, with James Vicini in Washington; Editing by David Holmes

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