The Yale Law Journal

VOLUME
132
2022
NUMBER
1
October 2022
1-325

Open Access, Interoperability, and DTCC’s Unexpected Path to Monopoly

Antitrust Law

abstract. For markets characterized by significant economies of scale, scholars and policymakers often advance open-access and interoperability requirements as superior to both regulated monopoly and the breakup of dominant firms. In theory, by compelling firms to coordinate in the development of common infrastructure, these requirements can replicate the advantages of scale without leaving markets vulnerable to monopoly power. Examples of successful coordination include the provision of electricity, intermodal transportation, and credit-card networks.

This Article offers a qualification to this received wisdom. By tracing the Depository Trust and Clearing Corporation’s path to monopoly in the U.S. securities clearing and depository markets, it demonstrates that open-access and interoperability requirements can serve as instruments by which dominant firms obtain and entrench their monopoly power. Specifically, by imposing high fixed costs to connect to common infrastructure, allowing dominant firms to dictate the direction and pace of innovation and investment, and reducing the scope for product differentiation, these requirements can prevent smaller firms from competing with their larger rivals. In these ways, open access and interoperability can exacerbate the very problems they were designed to address.

Our analysis helps to explain why important components of our financial infrastructure have become too big to fail. It also helps explain why, despite their highly concentrated structure, U.S. securities clearing and depository markets still exhibit relatively high levels of innovation and investment. More broadly, our analysis offers a cautionary tale for policymakers seeking to employ open-access and interoperability requirements to curb growing market power in Big Tech, social media, finance, and elsewhere. Open access and interoperability are unlikely to constrain market power unless larger firms are unable to dictate decisions about innovation and investment, and unless the costs of building, maintaining, and connecting to common infrastructure are allocated in a way that does not discriminate against smaller firms. Where this is not possible, open access and interoperability are unlikely to forestall monopoly control, though they might still improve market efficiency by exposing incumbents to the threat of new entry.

authors. Professor of Law, Cornell Law School; Assistant Professor of Law, University of Chicago Law School. The authors would like to thank John Armour, Brandon Becker, Anthony Casey, Nakita Cuttino, Luca Enriques, Yuliya Guseva, Howell Jackson, Louis Kaplow, Saul Levmore, Charles Mooney, Jr., Randal Picker, Eric Posner, Morgan Ricks, Ganesh Sitaraman, Thom Wetzer, David Wishnick, Danny Hirsch, and the editors of the Yale Law Journal, along with the participants of conferences and workshops hosted by the American Law & Economics Association, the University of Chicago, the Wharton School, Oxford University, and Vanderbilt University, for their extremely helpful comments and suggestions. All errors remain our own.

Introduction

Antitrust is enjoying something of a resurgence. A group of scholars known as the “New Brandeisians” have forcefully argued that antitrust—and antimonopoly more generally1—offers not just economic benefits, but also political ones.2 In addition to raising traditional concerns about economic efficiency, these scholars contend that large concentrations of economic power exacerbate income inequality, undermine the free expression of ideas, and threaten the democratic political process.3 Echoing this view, a 2020 report published as part of the House Judiciary Committee’s investigation of competition in digital markets concluded that the largest tech firms “wield their dominance in ways that erode entrepreneurship, degrade Americans’ privacy online, and undermine the vibrancy of the free and diverse press. The result is less innovation, fewer choices for consumers, and a weakened democracy.”4

But bigger sometimes really is better. When industries exhibit significant economies of scale, it is often more efficient for a small number of firms to supply the entire market.5 In fact, scholars and policymakers have argued over the past century that various industries are natural monopolies best served by a single firm.6 Today, these arguments are echoed by those who believe that the biggest tech platforms and financial institutions have become “essential social, economic, and political infrastructure.”7 On this view, financial services and the digital marketplace are “the railroads, bridges, and telegraph lines of a century ago.”8

These scale benefits pose unique regulatory challenges. As a preliminary matter, the drive to capitalize on the advantages of scale can lead firms to compete not just in the market but for the market.9 In the process, competing firms might make investments that turn out to be duplicative once a single firm secures monopoly control.10 After securing a monopoly, the winner may take advantage of its dominant market position by engaging in abusive pricing practices or other anticompetitive conduct.11 Monopoly control can also discourage innovation, with monopolists making investments designed to entrench their dominant position, thereby deterring investments by new and potentially more innovative firms.12 And, last but not least, depending on the nature of the products and services they supply, dominant firms might become systemically important, effectively forcing governments to bail them out during periods of financial distress. This is the so-called “too big to fail” problem that entered the public consciousness in the wake of the 2008 financial crisis.13

Proponents of more robust antitrust enforcement have long recognized the limits of traditional antitrust remedies in industries characterized by significant economies of scale. These remedies range from fines for abusive conduct, to rate regulation coupled with strict government oversight, to the breakup of dominant firms.14 Instead, scholars and policymakers have advocated for regulatory strategies that compel market participants to coordinate development and maintenance of socially useful market infrastructure.15 These coordination mechanisms include open-access and interoperability requirements. Interoperability requirements compel firms to work together to develop products and services compatible with those offered by their competitors. Interconnection requirements, a species of interoperability requirements, compel firms to build, maintain, and connect to common infrastructure through which to provide their goods and services. Open-access requirements, meanwhile, ensure that firms that exercise control over this infrastructure make it available to new entrants on competitive terms.16

Together, open-access and interoperability requirements are designed to forestall monopoly control, thereby mitigating market-power abuses and ameliorating the too-big-to-fail problem.17 In theory, these requirements also allow firms to capture the benefits of scale without granting a single firm monopoly control over an entire industry.18 For that reason, regulators have often used open access and interoperability to regulate so-called “public utilities”: firms that provide essential public infrastructure like roads, water, and electricity, and that often enjoy legal protection from competition.19

Recognizing these potential benefits,20 the New Brandeisians have urged regulators to use open-access and interoperability requirements to force competing firms to coordinate in developing and maintaining common infrastructure.21 And regulators seem increasingly sympathetic to this approach. On October 20, 2020, the Department of Justice (DOJ) filed a complaint against Google alleging that the firm’s control of popular access points has undermined the emergence of the next generation of internet-search platforms.22 Less than two months later, the Federal Trade Commission (FTC) filed a complaint against Facebook alleging that the social network “enforced anticompetitive conditions on access to its valuable platform interconnections.”23 Beyond Silicon Valley, as of 2021 no fewer than forty-eight states were considering legislation to expand access to broadband internet, many through open-access requirements.24 Scholars have also argued for the adoption of open-access requirements for internet service providers (ISPs), financial institutions, and energy companies.25 Should this movement gain momentum, we may find ourselves riding the crest of a new wave of public-utility regulation.

Given this prospect, we must seek to understand better the design, governance, and limits of the open-access and interoperability requirements that represent the cornerstones of this approach. To advance our understanding, this Article examines the historical impact of open-access and interoperability requirements in the context of two critical—yet critically understudied26—institutions at the heart of our financial-market infrastructure: securities clearinghouses and depositories.

Clearinghouses and depositories are the complex and opaque “plumbing” of global securities markets.27 Clearinghouses collect securities-trading data, verify trade details, and coordinate the transfer of securities and funds between buyers and sellers.28 Many clearinghouses also act as guarantors—standing between the parties on either side of a trade.29 Securities depositories play a complementary role, holding securities on behalf of their owners and maintaining and continuously updating electronic records of their legal and beneficial ownership.30

Securities clearinghouses and depositories are essential to the smooth, efficient, and resilient operation of modern financial markets.31 Indeed, it is no exaggeration to say that they are what make the scale and speed of modern finance possible. At the same time, the growing importance of these financial-market infrastructures has led to legitimate concerns about their systemic importance and market power.32 These concerns recently reached a fever pitch after long-standing rules imposed by the dominant U.S. securities clearinghouse temporarily forced the popular online trading platform Robinhood to suspend new buy orders in GameStop and several other popular “meme” stocks.33 The aftermath has sparked public outcry, congressional hearings, and even a U.S. Securities and Exchange Commission (SEC) investigation.34 It also revealed the enormous power wielded by an obscure but vital component of our financial-market infrastructure: the Depository Trust & Clearing Corporation (DTCC).

This Article sheds new light on how DTCC came to possess so much power over U.S. securities markets. Less than fifty years ago, American securities markets were supported by several regional clearinghouses and depositories, each connected to a regional stock exchange.35 Today, a single firm—National Securities Clearing Corporation (NSCC)—is the only remaining clearinghouse,36 while another—the Depository Trust Company (DTC)—is the only remaining depository.37 Even more remarkably, both NSCC and DTC are owned by the same parent company: DTCC.38

So, what happened? To answer this question, this Article provides the first detailed historical account of why these twin industries have become so highly concentrated. Intuitively, we might expect the answer to reflect the pronounced economies of scale and network effects associated with securities clearing and settlement.39 However, while this is undoubtedly an important piece of the puzzle, the answer also stems from a series of 1975 amendments to the Securities Exchange Act of 1934 that, ironically, were designed to enhance competition in U.S. securities clearing and depository markets.40 These amendments prohibited the SEC from granting NSCC and DTC monopolies over their respective industries. Instead, Congress ordered the SEC “to facilitate the establishment of a national system for the prompt and accurate clearance and settlement of transactions in securities.”41 In turn, the SEC ordered NSCC, DTC, and other clearing agencies to “establish full interfaces or appropriate links with the clearing agencies of designated regional exchanges.”42 Put simply: Congress and the SEC sought to use open-access and interoperability requirements to promote more vigorous competition.

Yet, less than thirty years later, NSCC and DTC were the last firms standing.43 Rather than promoting greater competition, the SEC’s open-access and interoperability requirements did little to prevent the gradual consolidation of U.S. securities clearinghouse and depository markets. Even more remarkably, these requirements actually played an important role in paving DTCC’s unexpected path to monopoly. They did so in three ways.

First, the SEC’s coordination requirements failed to eliminate the need for each regional clearinghouse and depository to build and maintain the technological and operational connections that enabled them to access the new SEC-mandated market infrastructure. The high fixed costs of building these connections placed a disproportionate burden on smaller firms, putting them at a competitive disadvantage.44

Second, the SEC’s coordination requirements enabled larger firms like NSCC and DTC to dictate the direction and pace of their rivals’ technological innovation. Whenever NSCC and DTC introduced technological improvements to their clearing and depository systems, the SEC’s coordination requirements effectively forced their regional competitors to make enormous infrastructure investments to ensure their own systems’ technological and operational compatibility.45 This, in turn, contributed to market consolidation, since whenever NSCC and DTC introduced improvements to their systems the regional clearinghouses and depositories had to follow suit—and to bear the substantial costs of building better, faster, and more resilient clearing and depository systems. In the face of these potentially enormous costs, each smaller regional player would eventually sell or otherwise cede control of its clearing and depository businesses to NSCC and DTC.46

Lastly, coordination requirements prevented firms from differentiating their clearing and depository services from those of their competitors. Because the interoperable interfaces mandated by the SEC envisioned that brokerage firms would be able to process trades that involved more than one clearinghouse or depository, each clearinghouse and depository was effectively forced to rely on the systems developed by their competitors.47 In practice, this meant that the smaller regional players had no choice but to rely on the systems built by NSCC and DTC.48 This ultimately undercut the ability of these regional players to compete with NSCC and DTC because their only path to profitability was to layer additional processes—and costs—on top of those already built by their larger rivals. For this reason, open access and interoperability quickly morphed into a form of outsourcing that resulted in firms offering virtually identical services.

The SEC’s open-access and interoperability requirements were not the only drivers of consolidation in U.S. securities clearing and depository markets. The competitive dynamics described in this Article played out in parallel with other seismic changes within the U.S. securities industry. These changes included the elimination of fixed-brokerage commissions, the introduction of the National Market System, the changing ownership structure and governance of U.S. stock-exchange groups, and a technological revolution in trade execution.49 Nevertheless, the consolidation of U.S. securities clearing and depository markets and the rise of DTCC—against the backdrop of the SEC’s open-access and interoperability requirements—represents an important and previously untold chapter within this broader story.

This chapter has implications well beyond the narrow and hypertechnical world of financial-market infrastructure. The first implication is for financial regulation. As a threshold matter, our analysis helps to explain how and why two of the most critical components of our financial-market infrastructure became too big to fail. Granted, securities clearinghouses and depositories likely would have been systemically important regardless of the prevailing level of industry consolidation.50 Yet the exit of the regional clearinghouses and depositories left U.S. securities markets without any competitors that could theoretically absorb the business of NSCC or DTC in the event of their financial distress. Viewed in this light, the SEC’s open-access and interoperability requirements have contributed to a lack of substitutability, leaving policymakers with few options other than public ownership or a taxpayer-funded bailout should NSCC and DTC ever find themselves on the brink of failure.51

The second implication relates to the potential impact of open-access and interoperability requirements on competition. By lowering high fixed costs and other barriers to entry, these requirements are designed to foster greater competition—and with it, greater dynamism and innovation in the development of new products and services. However, where the design and implementation of these requirements effectively force competitors to rely on the infrastructure developed by their rivals, this can severely limit the scope for meaningful product differentiation. Where this is the case, open-access and interoperability requirements will not only fail to promote greater competition and innovation but may actually hand the market to the firms that control the infrastructure through which their competitors must offer their products.52

The third and final implication relates to the design, governance, and limits of open-access and interoperability requirements as an alternative to traditional antitrust remedies. In theory, the benefits of interoperability stem from the coordinated allocation of the high, largely fixed, and potentially duplicative costs of developing, maintaining, and accessing common market infrastructure.53 However, our analysis suggests that where these costs are not readily divisible or actually divided, or where the division of costs places a disproportionate burden on smaller firms, then interoperability is unlikely to forestall monopoly control. Accordingly, while legally mandated interoperability is often touted as an alternative to both regulated monopoly and the breakup of dominant firms, in practice it can have significant anticompetitive effects. Mitigating these effects requires careful thought about not only the allocation of these costs, but also the governance of decisions regarding the direction, timing, and size of new infrastructure investments. This insight offers a cautionary tale—and a potential roadmap—for policymakers seeking to employ open-access and interoperability requirements to constrain growing market power in Big Tech, social media, finance, and elsewhere.54

This is not to suggest that open-access and interoperability requirements will always generate anticompetitive effects. While in the case of U.S. securities clearing and depository markets they served to concentrate market power in the hands of NSCC and DTC, in other markets they have offered a viable alternative to monopoly.55 Rather, our analysis suggests that where the costs of building a platform, network, or other infrastructure cannot be effectively allocated across competing firms, the use of these requirements as an alternative to monopoly control may, in fact, exacerbate the very problems they were designed to address. Whether this outcome is desirable depends on whether it is preferable to organize a given industry as a monopoly. The point is not simply that the anticompetitive effects of open access and interoperability can be harmful. It is that the tradeoff between economies of scale and market power is sometimes unavoidable.

In this vein, our analysis also suggests a qualified defense of open access and interoperability even where they fail to forestall monopoly control.56 Specifically, where there is uncertainty about whether a particular market is a natural monopoly, well-designed open-access and interoperability requirements might offer a mechanism that can reveal the optimal market structure. Simultaneously, even where these requirements do not initially prevent the emergence of a monopoly, they maintain the threat that new firms might one day enter the market, access the common infrastructure, and use it to offer superior products and services. This threat can spur ongoing investment and innovation by monopolists, thereby reducing—if not necessarily eliminating—monopoly rents.

We live in an interconnected world. Just as the nineteenth-century economy was built around railroads and the twentieth century around power, telecommunications, and international trade, so, too, will the twenty-first century be shaped by the emergence and growth of new networks, including online marketplaces, finance, social media, and Big Tech. In theory, open-access and interoperability requirements can help to prevent the concentration of market power in these network industries, thereby promoting greater competition and innovation. In practice, however, the design and implementation of these requirements are critical to their success. Poorly designed open-access and interoperability requirements will not only fail to achieve these important objectives but might exacerbate the very problems they are designed to address.

This Article proceeds in three Parts. Part I describes the conventional wisdom that open-access and interoperability requirements can replicate the economies of scale typically associated with a monopoly without handing control over an entire industry to a single firm. Part II traces the untold history of U.S. securities clearing and depository markets, describes the SEC’s open-access and interoperability requirements, and chronicles DTCC’s slow and steady march toward monopoly. Part III considers the potential policy implications of our analysis for financial stability and the design of open-access and interoperability requirements; it also assesses the potential benefits of these requirements compared with both regulated monopoly and the forced breakup of dominant firms.