The regulatory response to the global financial crisis has impacted nearly all major functions of the investment banking industry, including trading, capital and liquidity requirements, risk management, compliance and governance. As regulatory scrutiny has increased, profitability has, inversely (and expectedly), decreased. In response to narrowing profit margins, many banks have started pursuing "industry" solutions, eg joint ventures with competitors that establish shared utilities for specified back-office and compliance functions. While these joint ventures undoubtedly have procompetitive benefits and often have no connection to market-making activities, given the close cooperation among competitors that is necessary for the creation and operation of these entities, these joint ventures carry antitrust risks. This article explores these risks and provides best practices for how to manage them.
Joint ventures in the financial industry
The classic outsourcing model used by banks to streamline their cost structures has been to rely on pre-existing third-party vendors to take over certain non‑core or administrative functions (eg information technology). In recent years, however, banks have begun teaming up with each other and (in conjunction with hand-picked fintech firms) forging "industry" utilities that collectively outsource key functions, such as client onboarding and "know your customer" services, payment settlement services, and customer reference data management, to a co-owned entity.
These joint ventures often involve the creation of dedicated service companies in which all the participating banks own shares. Although these joint ventures may not necessarily touch on market‑making activities or involve the exchange of price sensitive information, they do often involve data and other information that is critical to client relationships and the overall functioning of each bank.
There are many benefits to these collaborations, eg a reduction in operating costs for the participating banks, economies of scale and synergies from the pooling of complementary resources, and opportunities to improve the accuracy and consistency of data and create a standardised data model that benefits customers and provides comfort to regulators.
Antitrust risks
While industry utilities in the financial industry most likely have significant procompetitive benefits, these arrangements do involve collaboration and contact with close competitors and thus entail some level of antitrust risk. In the U.S., given that these ventures involve integration of resources and shared capital investment, for the purposes of Section 1 of the U.S. Sherman Act (which governs horizontal conduct among competitors), they would be likely to be evaluated under the less restrictive "rule of reason".1 Under a rule of reason framework, an industry joint venture would only be unlawful if its anticompetitive effects substantially outweigh its procompetitive benefits. Potential anticompetitive effects may include the following:
Potential loss of competition
To the extent the joint venture partners compete with each other at all with respect to the provision of the ancillary or back-office functions being outsourced to the industry utility, competition could be diminished. For example, if one investment bank is able to distinguish itself from other investment banks based on the quality of its customer reference data or the ease or efficiency of its security payments platform, arguably there would be some anticompetitive effect from removing that competitive lever.
Facilitation of collusion
In the creation and operation of the industry utility, joint venturing parties must work closely with each other. Even though the scope of the industry utility may be relatively innocuous and truly related to administrative/back-office functions, participation in the joint venture does give banks the means and opportunity to engage in collusion in other areas.2
Foreclosure of other potential joint venture participants
Other banks (eg horizontal competitors) may seek to join the joint venture in some capacity. While the joint venture is free to set membership criteria and exclude others from participation on that basis, banks seeking to participate in the utility could be adversely affected if their exclusion prevents them from competing with the members of the joint venture.
Foreclosure of third-party providers
Many industry utilities involve the supply of a service that would otherwise be provided by a third‑party provider. Such collaborations may create or increase market power, to the dismay of impacted suppliers.
Guidelines for minimizing the antitrust risk
To minimize these antitrust risks, banks should keep in mind the following guidelines:
Conclusion
Like any endeavour that involves close cooperation and contact among competitors, bank joint ventures are susceptible to antitrust misconduct. If not approached with sufficient caution, a joint venture could draw the attention of antitrust regulators or private plaintiffs. But with the appropriate prophylactic measures in place, these antitrust risks can be managed effectively.
Footnotes:
1 Similar provisions exist in other jurisdictions, eg Article 101 of the Treaty on the Functioning of the European Union.
2 On this point, the credit default swap (CDS) litigation is instructive. Although the CDS litigation concerned the creation of a bank-owned electronic clearinghouse for credit default swap transactions, and thus involved conduct more closely related to the traditional market-making functions of investment banks, it nevertheless serves as a cautionary tale. Among other things, plaintiffs in the CDS case alleged that the banks conspired to foreclose competition from competing exchanges. The plaintiffs survived a motion to dismiss by, among things, demonstrating that meetings took place among the participating banks in which they alleged a conspiracy was hatched.
