NEW YORK — The Department of Justice has opened an investigation into credit derivatives, according to Markit Group Holdings Ltd., a prominent provider of data for the arcane but booming market that played a leading role in the credit crisis.
The Justice Department's antitrust division has requested information relating to price transparency in the credit derivatives and related markets, a person familiar with the inquiry said Tuesday. The requests were sent to Markit and its shareholders, which include the big banks most active in credit derivatives.
"We will work with the Department to provide any information requested of us," Markit said in a statement.
The move puts further pressure on a market whose loosely regulated, over-the-counter structure has proved lucrative for the banks that facilitate most trading. Advocates say the light-touch approach has made it easy to disperse risks and that the market sends important signals that trouble may be brewing at borrowers. But critics charge the market is susceptible to manipulation and facilitates destructive speculation about companies' creditworthiness.
"It is obvious that this has to be seen as another step towards regulating the over-the-counter market," Philip Gisdakis, head of credit strategy at UniCredit S.p.A. said in a note Tuesday.
Credit derivatives essentially work like insurance contracts, paying off for the buyer if the underlying debt goes into default. The instruments exploded in popularity over the past decade by offering banks, hedge funds and others a way to place bets on the creditworthiness of companies, mortgage holders and even countries.
Rising prices for credit protection set off alarm bells about troubled financial institutions such as Lehman Brothers Holdings Inc. during the crisis. Since trading generally takes place over the counter — for the most part directly between banks and brokers — regulators worry it's hard to tell who's doing what in the market.
Regulators also are concerned that some parties may be taking on more risk than they can support. American International Group Inc., for instance, ultimately needed a government rescue in part because it couldn't support huge obligations incurred by a unit that sold credit protection on complex securities.
Those concerns could turn into big profits for regulated derivatives exchanges like CME Group, which are currently shut out of the lucrative CDS trade. In May, the U.S. proposed giving the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission authority to require certain derivatives trades to be "cleared" — a guarantee function many exchanges provide in case one of the trading parties defaults. Trading of more standardized derivatives could also be pushed onto regulated exchanges outright.
Earlier this month, the European Commission outlined similar measures it is considering to limit the risk the derivatives market poses to the European financial system.
Markit, the financial information services company that runs the iTraxx Europe and CDX U.S. corporate CDS indexes, was established in 2001 and occupies a central position in the market, providing data and developing benchmark indexes. Shareholders include JPMorgan Chase & Co., Goldman Sachs Group Inc., Citigroup Inc., Deutsche Bank AG, Bank of America Corp., Barclays PLC, UBS AG, Morgan Stanley and others.
Founded by former bank credit-trading executive Lance Uggla in 2001, Markit collects price data from derivatives dealers and sells that information to clients, including hedge funds. Previously, investors had little insight into prices of contracts that are traded between investors rather than on a public stock exchange.
That greater transparency has helped fuel the spectacular rise of the credit derivatives industry in recent years. Markit has also expanded the range of debt that can be easily bet against by launching an array of credit-default swap indexes. Those same indexes have been criticized by some analysts for potentially increasing volatility in debt markets.
"Markit strives to enhance transparency and efficiency in the credit derivatives market by making all our independent data products commercially available to all market participants," the company said in an e-mailed statement.
This isn't the first time in recent months that the credit default swaps industry has been targeted by U.S. regulators. In May, the SEC filed its first insider-trading case related to credit default swaps, having paid relatively little attention to the market during the credit boom. Dozens of derivatives-related investigations are now under way.
Credit derivative markets showed little reaction to news of the probe. "People won't stop trading because of this," one market participant said. "It won't affect the mechanics of the market."