Financial services: in the focus of the competition authorities, with new challenges ahead

March 2020 | SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

March 2020 Issue

Few sectors have attracted more attention from the antitrust agencies in recent years than the financial sector. The last five years have seen unprecedented enforcement activity with multibillion-dollar fines and civil damages actions against the world’s leading banks in the US, the EU, the UK and other financial centres, such as Switzerland and Australia. There have also been efforts to extradite and imprison bank employees for their role in criminal cartels.

Investigations have focused on a range of issues: collusion on interest rate benchmarks (EURIBOR and LIBOR denominated in various currencies) and foreign exchange rates, collusion in secondary market trading in government bonds, collusion between members of underwriting syndicates following a syndicated offering of equities, collusion by asset-management firms during book-building for placings and initial public offerings (IPOs) and in the trading of precious metals. Certain of these cases have been directed at brokers as well as banks.

The ongoing criminal prosecution by Australian authorities illustrates the aggression with which these cases can be pursued, and the risks that banks and their employees face when legitimate cooperation goes too far. The case arises out of an equity placement of ANZ shares, when it instructed JP Morgan, Deutsche Bank and Citi to raise capital by issuing ANZ shares as an underwriting syndicate. Prosecutors allege that the three banks were unable to sell all of the offering and were stuck holding shares. In order to avoid flooding the market and undermining the share price, it is alleged that the three banks agreed on a plan to sell the shares slowly and at inflated prices. It has been reported that JP Morgan initiated the investigation by ‘blowing the whistle’. Charges have been brought against six executives from ANZ, Citi and Deutsche Bank, all of whom are contesting the charges.

Closer to home, the UK’s Financial Conduct Authority (FCA) fined three asset managers for colluding in a book-building process and during an IPO, in both cases before the share price had been set. The FCA, prompted by a whistleblower, found that the firms had disclosed to each other the price they were willing to pay and the volume of shares they were willing to buy. Hargreave Hale and River & Mercantile were fined, as was an individual fund manager at Newton Investment Management.

The cases illustrate a number of compliance challenges. First, because banks and brokers have multiple legitimate interactions through their trading activities and as members of syndicates. At what point does an informal or off-the-cuff remark about the market, or perceptions of how the market will evolve, reveal a bank’s confidential strategies? Second, since their interactions often take place in informal settings, both real and virtual (such as chat rooms), it makes it hard for banks to police in order to ensure compliance with their competition law and financial market regulations.

Such is the nervousness around the use of informal chat rooms that JP Morgan recently suspended a senior credit trader based in New York for using a WhatsApp group to communicate with his own colleagues. While denying that anything inappropriate had occurred, JP Morgan reported the matter to its various US regulators. The concern is understandable given the requirement on banks to be able to monitor employees’ communications for compliance purposes and the use that has been made of instant-messaging services, including WhatsApp, in many of the cases where fines have been imposed.

The FCA has previously warned about the risks of using messaging services, such as WhatsApp, which are encrypted, and thus hard for a bank to monitor. The issue has become even more challenging due to the rise of ‘bring your own device’ in preference to work-issued devices given the difficulty of preventing employees from installing apps on their own private devices.

What is coming next? The financial sector is at the centre of a convergence of antitrust concerns. There is growing and widespread interest in the way that algorithms, artificial intelligence (AI) and machine learning (ML) could be used, by accident or design, to create collusive outcomes. Automated trading algorithms are one example. The transparency created by blockchain and the development of standards around cryptocurrency are other examples in the sights of the antitrust agencies – as shown by the competition authorities’ interest in Facebook’s Libra initiative and ApplePay.

The FCA has issued a warning about the compliance risks posed by AI in the finance sector. It has also recently announced the creation of data science units as part of a strategy to develop data and analytics capabilities to improve the effectiveness of information collection. This forms one part of its focus on the use of advanced analytics and automation techniques to deepen its understanding of how markets function and allow the FCA to efficiently predict, monitor and respond to firm and market issues.

In parallel, French and German competition authorities have issued a long report on the risks and responsibilities for companies using algorithms, which has implications for the finance sector given the widespread use of trading algorithms in the sector. The authorities note that there could be a compliance risk even where you do not know your competitors are using the same algorithms (if use could reasonably have been foreseen). The head of the French authority commented that “companies should consider that they are responsible for any algorithms they use, even if provided by a third-party. Now, considering the legal implications it is important for companies to be able to explain what the objectives of the algorithms are, how they are managed and also for them to set up internal checks and balances. This means that the legal or compliance director should have frequent conversations with the chief digital officer”.

The report also recommends expanding the scope of a “hub and spoke” scenario to include not only the use by competitors of largely identical algorithms but also those that differ from each other whilst driving a collusive outcome. This could lead to third-party liability for algorithmic collusion between competitors.

All of this means that the banking sector can be expected to remain in the sights of the antitrust authorities for some time to come – and underlines the need for strong and effective compliance tools, recurrent training, a culture of openness not fear, and a genuine commitment to compliance at every level of the organisation.

Matthew Levitt is a partner at Baker Botts. He can be contacted on +32 (2) 891 7360 or by email: matthew.levitt@bakerbotts.com.

Matthew Levitt

Baker Botts