Nasdaq's Secret Agent Derivatives Campaign

As Congress was considering forcing most derivatives transactions to go through a clearinghouse for the first time, Nasdaq OMX (NDAQ), the New York-based stock exchange, saw a huge opportunity. It set its sights on winning a larger share of the lucrative business of clearing interest rate swaps. Such swaps are used to hedge against higher borrowing costs or to speculate on interest rate moves and represent a $348 trillion market, according to the Bank for International Settlements.

Just one problem: Clearinghouses, which process trades and guarantee payment in case either party defaults, are dominated by large Wall Street banks that are also among Nasdaq's biggest customers. To get around that uncomfortable fact, Nasdaq officials devised a stealth lobbying campaign to persuade Congress and regulators to limit bank ownership of clearinghouses.

"It is dangerous to state openly what they feel," says Michael Greenberger, a former Commodity Futures Trading Commission official who is now a University of Maryland law professor, "because those banks can decide to take their business elsewhere." The resulting skirmish is a vivid illustration of how companies sometimes turn to Washington to gain an advantage via regulation that they can't get in the marketplace, says Greenberger.

The dominant player in interest rate clearing is London-based LCH.Clearnet Group, which is majority-owned by the world's largest banks, including JPMorgan Chase (JPM) and Goldman Sachs (GS). The banks oppose strict ownership limits, arguing that clearinghouses need owners with enough capital and expertise to weather market disruptions. "The most likely sources of both are swap dealers," the Securities Industry and Financial Markets Assn., a trade group led by big banks, wrote in a November letter to regulators. Chicago-based CME Group (CME), the world's largest futures exchange, also clears interest rate swaps but is much smaller than LCH.Clearnet. Nasdaq's two-year-old clearinghouse for interest rate swaps, the International Derivatives Clearing Group, is even smaller, according to the exchanges.

Nasdaq, consumer advocates, and unions say the banks' dominance of both trading and clearing derivatives has driven up costs for companies that need to hedge the risk of changes in commodity prices or interest rates. The Justice Dept., in Dec. 28 letters to regulators calling for stringent limits on clearinghouses and derivatives trading platforms, also raised anticompetitive concerns.

As part of the exchange's lobbying campaign, Nasdaq CEO Robert Greifeld came to Washington during the financial regulatory overhaul debate and met personally with lawmakers, according to two congressional aides who were present and requested anonymity because the meetings were private. Michael Oxley, a former Ohio representative who advises Nasdaq's board, stood near the House floor during a vote on an amendment limiting bank ownership; reporters saw him buttonholing fellow Republicans.

An anonymous flier, titled "Myths That the TARP Banks Are Spreading About the Lynch Amendment," circulated on Capitol Hill about a measure by Representative Stephen Lynch (D-Mass.) to limit bank ownership of a clearinghouse to 20 percent. The flier, which Nasdaq eventually acknowledged drafting, denounced Wall Street firms as an "abusive cartel."

The final version of the Dodd-Frank law lets regulators decide where to set ownership limits. Nasdaq representatives have visited the CFTC and the Securities and Exchange Commission to discuss the issue, according to the agencies' websites. When the CFTC in October proposed two options for ownership limits, Nasdaq didn't submit a written response. The agency, however, did receive letters supporting Nasdaq's position that were purportedly from Arkansas residents, including a rural county sheriff and a Burger King (BKC) franchise owner.

Bloomberg News reported in November that those letters were forgeries generated as part of a campaign by the Dewey Square Group, a Boston-based public affairs firm. The Justice Dept. is investigating. The fake letters, which a Dewey Square principal, Ginny Terzano, says were unauthorized and sent by a subcontractor without the firm's knowledge, contained the same message that Nasdaq has been pushing in Washington as it tries to muscle its way into the derivatives business. Nasdaq's chief spokesman, Frank De Maria, declined to say whether the exchange hired the firm responsible for the letters.

The bottom line: To bulk up its swap clearing business, Nasdaq tried to use Washington to get what it couldn't win in the marketplace.

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