CFTC Said Probing ICAP on Swap Price Allegations: Credit Markets

ICAP Plc brokers and as many as 15 Wall Street banks are being probed by the Commodity Futures Trading Commission for possible manipulation of interest-rate swap prices used as a benchmark in the $379 trillion market.

The CFTC has issued subpoenas to about a dozen current and former employees at ICAP’s Jersey City, New Jersey, swaps-brokering group, nicknamed “Treasure Island” because of the size of the commissions it earns, said three people familiar with the investigation. Dealers including Goldman Sachs Group Inc. and Deutsche Bank AG that contribute prices used to set the daily swap rates also have been subpoenaed, two people familiar with the matter said.

The so-called ISDAfix prices and intraday trading levels that ICAP displays on an electronic screen known as 19901 are used by everyone from corporate treasurers to money managers to gauge wholesale funding costs. The Federal Reserve includes the rates in a daily report on money markets, and they’re used to set daily values for much of the global rate-swaps market.

“That screen is critical,” said David Kelly, director of financial engineering at Calypso Technology Inc. in New York, who helped design the underlying analytics of the 19901 screen in the early 2000s. “That screen makes or breaks a lot of profit and loss, so clearly there’s a lot of opportunity for influence.”

Libor Connection

The CFTC is investigating whether ICAP brokers colluded with dealers who stand to profit from inaccurate quotes, including failing to update published prices after trades occur, one of the people said.

The U.S. regulator is probing the swaps trading as it works with European counterparts in the rate-rigging scandal surrounding the London interbank offered rate. ICAP brokers in London have passed on requests from dealers asking rate-setters at rival banks to make favorable submissions, e-mails released as part of the European probe show. UBS AG, Royal Bank of Scotland Group Plc and Barclays Plc have paid $2.6 billion in fines for rigging Libor rates.

Stephanie Allen, a CFTC spokeswoman, said the commission doesn’t comment on enforcement issues. ICAP said in a statement it maintains policies prohibiting the alleged behavior and is cooperating with the CFTC’s wider inquiry. The stock fell as much as 4.5 percent before ending the day in London up 1.1 percent to 295.9 pence.

‘Treasure Island’

ICAP, the biggest broker of interest-rate swaps between banks, is paid commissions based on the size of the trades it matches. On average, $1.4 trillion of transactions were traded daily on ICAP’s systems in 2012, the company said in its annual report.

Like Libor, which is the rate at which banks say they would lend to each other, ISDAfix is derived from a process where 15 banks submit bids and offers for swaps in various currencies and denominations, according to the website of the International Swaps & Derivatives Association, which created the rate in 1998 with the predecessors of Thomson Reuters Corp. and ICAP.

The rates are distributed by Thomson Reuters, Telekurs and Bloomberg LP, the parent company of Bloomberg News, according to the ISDA website.

The contributors to ISDAfix are Bank of America Corp., Barclays, BNP Paribas SA, Citigroup Inc., Credit Suisse Group AG, Deutsche Bank, Goldman Sachs, HSBC Holdings Plc, JPMorgan Chase & Co., Mizuho Financial Group Inc., Morgan Stanley, Nomura Holdings Inc., Royal Bank of Scotland, UBS and Wells Fargo & Co., according to ISDA.

Representatives at the banks declined to comment.

ISDA Subpoena

ISDA also has received a subpoena from the CFTC related to the swaps benchmark and has provided information to the regulator, Lauren Dobbs, a spokeswoman for the New York-based industry and lobbying group said in an e-mailed statement. “We are cooperating fully,” she said.

Rate swaps, which investors and companies use to exchange fixed- and floating-rate obligations, involve a series of payments that are determined by rising or falling interest costs over the lifetime of the contract. They last as many as 30 years and are denominated in notional amounts that are used to calculate payments and don’t represent money that has changed hands.

Manual Prices

One potential source of price manipulation being probed by the CFTC is tied to ICAP brokers not updating the rate-swap price on the 19901 screen after they facilitate a trade between two banks, according to one of the people, who asked not to be identified because the matter is private, and a former ICAP broker in the Jersey City rate-swaps group.

ICAP enters those prices manually onto the screen, and dealers tell the brokers not to put trades into the system until all their business in a transaction is done, which skews current market prices, according to the former broker, who said he witnessed such activity first-hand.

During his time working on 19901, Kelly said he witnessed dealers pressuring brokers to move the screen price after a trade, though no broker ever did.

“There can be disagreements about the timing of the movement of the screen, which can be misconstrued as manipulation,” he said. Dealers “threatened to pull their business, they threatened to do whatever. The brokers in a tough spot, do they delay by a few seconds? They make it very hard on the brokers.”

Borrowing Benchmark

About 6,000 companies and financial firms subscribe to the prices published on the 19901 screen, according to ICAP. Those values are accepted as a legal settlement price by which swaps traders can terminate contracts or to mark the value of positions, according to ISDA.

Corporations also use 19901 to see where current rate swaps are trading relative to government benchmarks, and then add in their cost of borrowing based on their credit rating to see where they would be able to issue bonds, Kelly said.

Elsewhere in credit markets, a benchmark gauge of U.S. corporate credit risk held at about the lowest since a new version of the index started trading three weeks ago.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell 0.1 basis point to 85.4 basis points as of 12:37 p.m. in New York, the lowest since Series 20 of the index started trading March 20, according to prices compiled by Bloomberg.

Europe Benchmark

In London, the Markit iTraxx Europe index tied to 125 companies with investment-grade ratings fell 1.1 to 114.7, the lowest since March 18, Bloomberg prices show.

Credit swaps typically fall as investor confidence improves and rise as it deteriorates. Contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, declined 0.23 basis point to 14.8 basis points. The measure narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Bonds of Charlotte, North Carolina-based Bank of America are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 5 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

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