Bloomberg reports that the U.S. Securities and Exchange Commission is looking into whether financial firms colluded together so that prices in the $6 trillion credit default swaps indexes market became skewed. According to the news outlet’s source, the regulator is trying to figure out whether dealers misrepresented index prices. The SEC is reportedly examining indexes that are less-liquid and actively traded.
With the credit-default swaps benchmark, investors can make bets on whether companies, mortgage-backed securities, or countries will default. Trading in swaps index contracts has increased in recent years because investors have been looking for easy ways to make bets via speculation.
At the conclusion of every trading day, benchmark prices for indexes are calculated by third-party providers according to dealer quotes. This sets the level at which traders are able to make their positions. This process resembles the way markets that don’t trade on exchanges establish benchmark prices.
Wall Street’s biggest banks have typically dominated credit swaps trading as they’ve taken on the role of market maker to institutional investors, including insurers. The dealers transmits quotes to clients vie email or on electronic screens that show the price at which they will buy or sell insurance that has defaulted. As the perception of credit risk shifts, those prices go up or down.
However, ever since the economic crisis—when credit default swaps became known for making occurring losses greater and spreading risks from the US housing crisis to elsewhere in the world—a lot of trading is now done through electronic platforms with clearing houses. The latter backs the transactions, which hopefully lowers counterparty risk while enhancing transparency.
Banks Said to Face SEC Probe Into Possible Credit Swap Collusion, Bloomberg, December 4, 2015