Tuesday, May 17, 2011

EC Puts Up Stop Sign for the Market Group's Involvement in the ECB's ABS Data Warehouse [Update]

Bloomberg published an article on the European Commission's probe of financial market data vendors who control essential infrastructure.

As discussed previously on this blog (see here), the ECB is acting as a catalyst to spur the creation of a centralized ABS data warehouse.  The data warehouse will process, verify and ultimately distribute standardized loan-level information on all existing and future structured finance deals to all market participants.

In a recent International Asset-Backed Strategy report, an RBS analyst observed of this effort
[W]e would see an ECB-endorsed (even if “non-exclusive”) data provider as an effective market monopoly in the ABS data aggregation business.
Hence, it will be on the European Commission's radar as essential infrastructure.

The report continues
The ECB’s letter of intent states that “To the extent possible, market participants will have the opportunity to use and invest in the Data Warehouse subject to entering into appropriate legal arrangements” – while this statement appears to encourage a ‘market-owned’ data provider, we think the difficult practicalities of creating such a socialised venture will mean that the project likely ends up going to a private firm(s). 
This was in fact directly indicated by a press release issued on April 28th from a group of market participants (originators and investors) stating that they will oversee and manage the selection process for the construction and administration of the Data Warehouse, which according to the press release will allow ABS issuers to submit loan-level data electronically, which will then be verified and audited for compliance with the ECB’s criteria requirements for repo eligibility. 
Every member of this group of market participants, the Market Group, has a conflict of interest.  Another big, red flag for the European Commission.
European Union regulators, who are investigating 16 investment banks over the swaps market, will examine the “control and dissemination” of financial-market data for possible antitrust abuses. 
The European Commission will investigate whether data providers are engaging in abusive behavior by “attempting to leverage privileged access to information,” Joaquin Almunia, the EU’s competition commissioner, said in a London speech today. “I also intend to discuss the legitimate scope of intellectual property rights claims on such data,” Almunia said.
Almunia is increasing the EU regulator’s scrutiny of financial markets. Last month, he announced a probe into whether 16 banks ... colluded by giving data to Markit, a financial information provider.  
The commission is also checking whether nine of the banks struck deals with ICE Clear Europe, a clearinghouse for derivatives, that prevent other clearinghouses from entering the market. 
This should be a stop sign for the ECB and its involvement with and potential endorsement of the Market Group's version of the ABS data warehouse.
The commission is ramping up antitrust enforcement in the financial services sector,” Suzanne Rab, a lawyer at King & Spalding in London, said in an e-mail “An underlying theme is the transparency of and access to data.” [emphasis added]
Almunia, who is set to examine Deutsche Boerse AG’s bid for NYSE Euronext, said he is opposed to “essential” market infrastructure being controlled by a small number of companies. 
“We should prevent that any one entity or group controls essential infrastructure -- be it a trading platform, a clearing platform or a pre-trading service -- to the benefit of a restricted few,” he said.
This problem is particularly acute if the companies all have conflicts of interest in the control and dissemination of the data.

This problem is mitigated if the firms that construct and operate the ABS Data Warehouse and therefore control the essential infrastructure are verifiably free of conflicts of interest with existing structured finance market participants.

This requires that any firm that is involved in either the day-to-day operation of the ABS Data Warehouse or the Coordinator role should be required to make a full disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

  • Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.
  • Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?
So long as these firms, like your humble blogger's, do not have conflicts of interest with existing market participants, they are motivated to do what is best for the structured finance market.  After all, they make money by seeing that the structured finance industry is successful.

The Bloomberg article highlighted another type of anti-trust concern.

... Standard & Poor’s offered to change its pricing policy in Europe to overcome antitrust concerns over licensing fees for securities identification numbers, the commission said earlier today.
This type of anti-trust concern will not be a problem for the ABS Data Warehouse your humble blogger would operate as the data warehouse will provide loan-level data for free to all market participants.


The following are the highlights from a May 16, 2011 speech by Mr. Almunia, the Vice President of the European Commission responsible for Competition Policy to the Cass Business School in London.

The speech touches on many of the themes addressed on this blog under the FDR Framework.  This includes the need to replace opacity with transparency so that all market participants have access to the useful, relevant in an appropriate, timely manner.  This includes the need to eliminate conflicts of interest so that investors can trust this data.
Let me start by talking about the challenges we are facing. Promoting competition, cross-border integration, and transparency in the financial markets has been part of the European Union’s efforts to build and strengthen the Single Market for many years. The need for EU-wide oversight of the financial sector became apparent in the 1990s as the Union moved towards closer economic integration and the single currency. 
This recognition led to the adoption of the Financial Services Action Plan of 1999, which comprised 42 separate measures on securities, banking, insurance, mortgages and pensions. The plan resulted in major pieces of legislation, including the Capital Requirements Directive, the Markets in Financial Instruments Directive – or MiFID – and the Market Abuse Directive. As our first wave of legislation was being implemented, financial markets were changing fast.
  • Technological innovation brought new organisations and practices such as broker crossing networks, systematic internalisers, and algorithmic and high frequency trading.
  • Ever more complex financial products and derivative instruments were being introduced, and
  • There was a massive rise of over-the-counter trading, which is now estimated at around 40% of all equity trades.
More importantly, the spectacular growth of trade in new financial products took place in a very opaque environment. In that environment, too much risk was being taken, also because risk was being mispriced. In addition, the crisis generated suspicions of market manipulation and abuse which contributed to damage investors’ trust in financial markets – and these suspicions have not dissipated yet. 
The EU has responded to these conditions by launching a comprehensive review of its existing legislation. The goals are to bring more transparency and stability to financial markets and to extend the scope of regulation to new financial instruments and infrastructure. 
Almost three years since the crisis erupted, financial markets are the scene of dramatic consolidation of trading platforms and infrastructure. This is due to a recovering environment for financial trading and to the imperatives of globalisation and technological change. 
... These are some of the current challenges in the financial services industry; now I would like to talk about what the joint action of competition policy and regulation at EU level can do to address them. 
... The regulatory measures taken by the European Commission will shed more light into the way financial markets operate and will prevent a dangerous accumulation of risk. But regulation alone is not enough. Whereas regulation tackles broad structural market failures, you need competition policy to tackle the harmful behaviour of individual market participants. 
Competition control should ensure that the actual evolution of the market does not lead to structures that harm users and legitimate market participants. In particular, we should prevent that any one entity or group controls essential infrastructure – be it a trading platform, a clearing platform or a pre-trading service – to the benefit of a restricted few. 
I am aware of the debate on inter-operability and the question of whether increased competition and the proliferation of market actors can undermine stability, but I cannot see a problem here. I believe that competition and stability are not at odds. If market participants comply with strict prudential requirements, I see no risk in having many of them supplying services to investors. In fact, I see potential gains. The level of concentration in the markets should reflect the search for optimal efficiency; it should not reflect the actions of powerful market players that have excluded potential competitors. 
So, in my view this is not a real danger. Let me tell you what I believe is one of the major problems in wholesale financial markets. Regulatory initiatives have gone a long way to increasing transparency of over-the-counter trade vis-à-vis regulators. But for a market to function well there must also be transparency vis-à-vis all market players. Market data that are necessary for a good appreciation of market conditions and for the efficient supply of information, trading and clearing services are not sufficiently available to market participants for many financial products. 
I think it is time we examined the control and dissemination of market data to establish whether there is abusive behaviour on the part of their owners attempting to leverage privileged access to information to foreclose rivals or distort the market. I also intend to discuss the legitimate scope of intellectual property rights claims on such data. 
... Now I would like to move to the third and final part of my presentation and give you a quick update of our current work in competition enforcement. The first two cases I will mention are those against Standard & Poor’s and Thomson Reuters. These two cases involve financial data or market infrastructure that may be important for the operation of markets. 
Our case against Standard & Poor’s regards the distribution of International Securities Identification Numbers developed by ISO, the International Organisation for Standardisation. S&P holds a monopoly position in the assignment of these ISO numbers to new securities issued in the US and in their distribution to the whole financial community. 
European investors have complained that S&P imposes license agreements and demands fees for the usage of the data even if they are downloaded from other vendors, something which is contrary to ISO rules. 
Our concern is that S&P may be abusing its dominant position by charging excessive prices.  
... The case involving Thomson Reuters is about the restrictions the company imposes on the use of Reuters Instrument Codes – or RICs. For example, customers of Thomson Reuters cannot cross reference them with identifiers of other vendors to retrieve data from them. That makes switching to an alternative data feed vendor costly and difficult. We are concerned that the practice could amount to an abuse of dominant position.
... Finally, I would like to talk about two new antitrust investigations into the markets for Credit Default Swaps; which are the first cases we have opened in the market for derivatives. 
The first case involves 16 investment banks and Markit, the leading provider of financial information in the CDS market. We want to find out if the banks are jointly coordinating the control of the information flow on CDS trade to prevent other providers and data vendors from developing competing services. Our preliminary investigations suggest that Markit may receive de facto exclusive information on the transactions and positions of many of these dealers. In addition, Markit’s licence agreements may be restricting the development of the market. 
The second case involves nine large banks – all of them also part of the first investigation – and the agreements they concluded when a company called The Clearing Corporation was sold to Intercontinental Exchange, or ICE. In this operation, the nine banks gave themselves preferential fees and a profit-sharing mechanism which gives them strong incentives to use ICE’s services with a de facto foreclosure effect on other clearing houses. Finally, we are investigating ICE’s fee structure, which may give an unfair advantage to the nine banks and discriminate against other dealers. If confirmed, this could be an abuse of dominant position to the detriment of potentially efficient competitors. 
... Over the past twenty years or so, the financial services sector has become increasingly larger and complex. No one knows this better than you, given that the wider industry accounts for around 14% of Britain’s GDP. Today, overseeing a few investment banks and specialised traders is simply not enough. We need to extend oversight beyond traders and banks to cover infrastructure owners, intermediaries, information services providers and possibly more. 
Competition enforcement and regulation must not saddle the industry with an unnecessary burden and must not stifle innovation. But we must make sure that the market develops in ways that are compatible with long term stability and efficient growth. We need deep and liquid financial markets. We need a system that gives participants all the information they need to fully understand the risks they are taking when they invest in a product and to fully appreciate the price they are paying. Participants need to know who their counterparties are and what their exposures are. Above all, we need to promote a system that participants can trust. 
I will continue to enforce EU competition law against collusion between firms and the undue influence of powerful players. I will also use every opportunity – such as our meeting today – to remind everyone to play by the rules. This is a responsibility that every player in these markets has towards their competitors, their customers, and towards society at large.

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