The dust is starting to settle on a series of feuds between custodial banks and institutions that believe they were short changed over foreign exchange services. Last month, BNY Mellon reached a partial settlement with the Department of Justice over claims it overcharged clients on FX transactions. BNY Mellon agreed it would be transparent to clients about the way it sets FX pricing.
Three years after a whistleblower – a former BNY Mellon employee – leaked confidential information supposedly showing the firm exploited the lack of transparency of FX transactions, the foreign exchange industry has changed for good.
Custodians are working toward giving clients what they want – more transparency and greater reporting on FX pricing – but FX revenue for custodians continues to plummet as pensions opt for alternative providers. But experts question whether it is institutional investors themselves that are to blame for letting custodians process FX transactions at spreads they were unhappy with – in some cases for years.
“The settlement is in BNY Mellon’s favour,” said Josh Galper, managing principal of Finadium, the custody and securities lending consultancy. “They are already taking action to provide more alternatives for clients, and provide clients with data about the rates they are getting versus the rates in the market. The fact that BNY Mellon said they would do that to the Justice Department really is saying, ‘Yes, we’re going to provide the data just as we are already doing’.”
BNY Mellon said it provides full transparency with regard to the way it prices its FX transactions. Each day, the firm publishes a guaranteed range of FX rates. Clients also have access to daily reports showing the rates applied to the previous day’s transactions.
BNY Mellon is “pleased with the progress represented by this agreement,” according to a statement. “While we are confident that we have provided our clients and their investment managers with the information they need to make informed trading decisions, this agreement addresses disclosure questions raised by the US Attorney and is consistent with our on-going commitment to implement enhancements that will benefit our clients.”
More legal trouble
BNY Mellon is not the only global custodian involved in litigation over foreign exchange transactions. The California attorney general launched a lawsuit in 2009 against State Street, claiming the firm overcharged California public pensions CalPERS and CalSTRS on FX transactions from 2001 onward. The suit set in motion a slew of lawsuits by public pensions against their custodians and the on-going case attempts to recover $56 million from State Street.
The remaining BNY Mellon lawsuits – by attorneys general in Florida, Virginia and New York – were filed after former BNY Mellon employee Grant Wilson leaked information purportedly containing evidence the custodian added “fictitious” charges on top of normal FX transaction fees. State Street and BNY Mellon both vehemently deny any wrongdoing.
Change of habit
In 2009, State Street revamped the way it discloses FX pricing, launching comprehensive pricing data, including markups and markdowns – methods not dissimilar from BNY Mellon’s.
“State Street has always accurately disclosed the amount of currency exchanged in every foreign exchange transaction where State Street Global Markets is the counterparty, including every indirect FX transaction,” said a spokesperson. “Among other things, this information has been available to custody clients and their investment managers via our online client portal. Beginning in 2009, we provided additional information about the way we set rates for indirect foreign exchange transactions, including the difference between the rates we set and interbank market rates at the time that State Street Global Markets sets them.”
Institutional clients are showing greater scrutiny of FX pricing and taking their FX business elsewhere. Massachusetts PRIM (Pension Reserves Investment Management) state attorney general has filed a complaint blaming the pension’s custodian BNY Mellon of unfair FX pricing, and is said to have moved some of its FX business to an alternative provider, Russell Implementation Services.
Institutional clients are also paying closer attention to the spreads being charged by their custodians now that BNY Mellon, State Street and others are providing more detail about the way prices are set. “If BNY Mellon is having to answer more questions about FX, or show more transparency in its FX pricing, that’s something clients are going to pay attention to,” said Galper.
Better the devil you know
Although clients may be switching providers for some services formerly done by their custodians, such as MassPRIM using an outside FX provider, it is believed none have switched custodians entirely. Institutional investors are maintaining their relationships with their custodians, in some cases even at the same time they are taking them to court. CalPERS renewed its contract with State Street in July, despite its on-going lawsuit, and none of the pensions suing BNY Mellon are believed to have switched provider.
Javier Paz, senior analyst at Aite Group, said it is not easy to migrate assets from one custodian to another. “There is a lot of convenience of continuing to do business with the same custodian.” Paz said. “But there has been some movement on the FX side of the business to other firms that are trying to create a niche, providing more transparency on how they execute particular trades and how certain cost savings are achieved. That balances the need for convenience.”
But the question, analysts say, is not necessarily whether custodians are at fault for overcharging on FX transactions. It is also whether pension funds, as fiduciaries, should have paid more attention to the pricing they were getting all along.
“My primary concern about lawsuits in FX and related areas is the fiduciary responsibility of asset holders themselves,” Galper said. “In many cases, we find that asset holders could have paid greater attention to these financial activities while they were occurring, rather than seek to recoup perceived losses through a lawsuit.”
Consulting firm Mercer recently launched a service letting institutional investors request reviews of spot and forward FX transactions undertaken at multiple trading locations, allowing them to determine the competitiveness of prices from their custodian or other FX provider. “Due to the opaque nature of FX markets, there has been a lack of investor oversight on FX transactions, often leading investors to pay more for trades than they should, which can erode the value of their assets considerably,” Mercer wrote in a statement at the launch of the service.
The fact that a market exists for such a product is another sign institutional investors are paying closer attention to FX fees.
By Christopher Gohlke, Global Custodian, an Asset International publication