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FX Transaction Cost Analysis

FX Transaction Cost Analysis is hot topic that has been getting extensive coverage in the press. We have organized some of the key stories for our clients to remain aware of how failing to take a proactive approach in understanding and dealing with associated fees can lead to major headache.

FX TCA in the News

22 Jul '13

Forex Trading: Plan Sponsors, Not Custodians Have Fiduciary Role Forex Trading: By Chris Kentouris, Senior Contributing Editor

If investment funds didn't know it already, a recent New York court ruling in favour of JP Morgan Chase should have made it crystal clear. When it comes to executing foreign exchange transactions caveat emptor is the rule to follow. US pension plans and other asset owners, not their custodians, face the onus of ensuring they get the best deal possible.

Custodians typically execute forex deals to meet trade settlement requirements and disperse income and dividend payments to investment fund clients. At the core of the dispute involving JP Morgan is whether or not it followed its fiduciary obligation to a pension plan by earning too much in executing forex deals and not disclosing just how much it made. The US$1.4 billion Louisiana Municipal Police Employees Retirement System (LAMPERS), which has relied on JP Morgan as its custodian since 2005, seems to think so and in September 2012 sued the bank in a New York court. Rather than disclosing the profits made from FX trading, the bank combined the exchange rate -- and its profit -- with the conversion rate it provided its clients, the pension plan claims.

However, Judge Denise Cote counters that JP Morgan did nothing wrong. It was LAMPERS that didn't do its homework. "LAMPERS identifies no foundation for its reasonable expectation that, in addition to reporting the charged exchange rate, JP Morgan would also reveal its mark-up on the indirect FX transactions," she writes in her ruling on July 3. Although the custody contract with JP Morgan does stipulate that LAMPERS would pay no transaction fees, the rates charged by the bank do not constitute fees as that term is used in the custody agreement, she explains.

In fact, according to Judge Cote, JP Morgan was not even contractually obligated to perform FX transactions at the best execution rates, charge the pension plan at the rate it paid or even deal with foreign exchange trades at all because the actual service wasn't explicitly stated in the custody contract.

The bank didn't breach its fiduciary duty by making a spread on the foreign exchange transaction, because it never had any fiduciary obligation. Apparently, FX trading wasn't even mentioned in the custody contract. The clincher: "The relationship of a custodial bank to its client is one of a depositor to a customer, a relation that does not, without more, give rise to a fiduciary obligation," says Judge Cote.

The ruling marks the second time the same court for the Southern District of New York dismissed a case involving poor forex trading within the same week. Yet another judge, Lewis Kaplan, says that the Iron Workers Mid-South Pension Fund, which filed a shareholder derivative suit, failed to prove BNY Mellon's C-level executives knew and allowed price manipulation before 2011.

What should an investment fund do? Judge Cote offers some inkling in her decision. LAMPERS could have protected itself a lot better by signing a separate master foreign exchange contract that stipulated transaction terms and conditions and cross-checked the rate used as disclosed in the account statement with foreign exchange benchmarks, she says.

The answer sounds pretty straightforward, but forex experts say the work is far from easy. With no set exchanges, currency trading takes place in a decentralized over-the-counter market. Custodians will usually execute forex deals -- critical to completing trade settlement and paying income and dividends -- as a principal to the transactions, so their profit margin is reflected in a markup rather than commission. A markup is perfectly legitimate, but an investment fund still need to determine if it is reasonable and that's a pretty big catchword.

Defining the specific terms and conditions of what the best deal means is a good start, but doing the math can be time-consuming and onerous without the right data. Fund managers could theoretically do the work, but more often than not want to concentrate on generating alpha and as forex trades fall within the custody agreement between the investment fund and its custodian, fund managers are practically speaking the odd men out. Investment funds do have the skill set to do the job on their own, but might not have the time and manpower, prompting some to turn to third-party specialists, otherwise known as transaction cost analysts for help.

"Although using transaction cost analysis for forex deals still trails equity transactions, investment funds are starting to rely on such analysis to know whether or not their custodian bank or other forex counterparty is within an accepted range of bids and offers," says Amarjit Sahota, director of Klarity FX, a San Francisco transaction cost analysis firm specialising in forex trades. "It isn't an exact science, but without measuring how custodians and other counterparties are performing, an investment fund cannot manage the forex execution process."

3 Jul '13

Buyside Looks to TCA to Improve FX Trading
Traders Magazine FX REPORT: By James Armstrong (extract)

The dust is beginning to settle following a string of lawsuits from pension plans and other institutional investors alleging the sellside mishandled their foreign exchange trades. While the courts are still working out who is to blame in the matter, the buyside is turning its attention to how to address FX trading challenges in the future. More and more, they're using trade-cost analysis, a tool borrowed from the equity world, to improve FX trading and get better returns for their investors. What they're discovering, however, is that TCA for currencies isn't the same as it is for equities.

Firms who offer TCA for foreign exchange transactions need to really understand the FX market. The buyside today is looking not just for firms experienced in transaction-cost analysis, but for experienced TCA firms that are also able to apply their analysis to foreign currencies.According to Amarjit Sahota, director of FX TCA services at Klarity FX, multi-bank platforms are working well for large retirement systems like CalPERS, but smaller retirement systems typically outsource everything to investment managers, and the smaller managers don't always have the clout to get the best prices. In most cases, managers are too occupied with returning alpha to worry much about their foreign currency trades. Other managers, though, have dealt with FX head-on, sometimes discovering they can improve alpha by saving money on currency transactions. The problem for managers can then be convincing their board of trustees to go along. Many agreements that the buyside has with custodian banks call for an extra charge if clients want to trade away from the custodian for their currency transactions. Trustees don't want to incur those extra charges, even though managers might be convinced they can get better rates elsewhere. How then can someone tell if the better prices on FX transactions are worth the trade-away fees? That's where TCA comes into play.

"We've been in positions where the investment manager has said, 'Thank you for turning up and educating the board of trustees,'" Sahota said. Managers can feel handcuffed, knowing they are paying too much on FX but not able to trade away from their custodians, he added. Once they have proof from a TCA provider that they can get significantly better prices, the trustees are more amenable to sign off on paying fees and allowing more competitive bidding of transactions, so long as it improves trading results.

After all, one of the advantages of trade-cost analysis has always been that it can provide hard evidence to those skeptical about some aspect of trading. That's why even some professional currency traders are turning to TCA these days. They might not feel they need it for themselves, but they often need it for their clients.
(Traders Magazine)

21 Mar'12

Santa Barbara County Employees' Retirement System (SBCERS) selects Klarity FX
Klarity FX is delighted to have been chosen by Santa Barbara County (Calif.) Employees' Retirement System to provide transaction cost analysis.

At its March 14 meeting, the board hired two transaction cost analysis firms. Zeno Consulting Group was hired for regular trading and Klarity FX was hired specifically to analyze foreign exchange transactions.

19 Mar '12

Ohio pension plans drop custodians BNY Mellon, State Street
The changes come after Ohio Attorney General Mike DeWine filed a lawsuit March 12 in the Court of Common Pleas of Franklin County in Columbus against BNY Mellon on behalf of the police and school employees pension funds. The suit seeks more than $16 million in damages for losses incurred by foreign-exchange trades by BNY Mellon, the funds' custodian. The police fund had hired State Street to replace BNY Mellon in late 2010.
Mr. Mandel, in a news release, cited similar lawsuits by the U.S. Department of Justice and other states against State Street Corp. as the reason for its termination.

12 Mar '12

2 Ohio pension funds sue BNY Mellon over foreign exchange
“As a result of my office’s investigation into this matter, our complaint alleges that BNY Mellon violated the terms of their custodial agreements with the Ohio funds, and exploited the volatility of the foreign currency market to their advantage at the expense of Ohio pensioners and their families,” said Mr. DeWine in a news release.
The suit alleges that BNY Mellon collected currency trades for their “standing instruction” clients and set the price near or during the day’s least-favorable exchange rates.
The lawsuit “recycles baseless allegations from other lawsuits brought elsewhere by the same plaintiffs’ lawyers,” said Kevin Heine, spokesman at BNY Mellon, in a prepared statement. “As we have stated previously, we are confident we are right on the facts and the law. We provide our clients with a valuable service at competitive prices and any suggestion otherwise is simply wrong.”

27 Feb '12

Federal, New York authorities question State Street about forex trades
The U.S. attorney for the Southern District of New York and the New York attorney general have made inquiries to State Street Corp. regarding the company's “execution methods” for non-negotiated foreign-exchange trades that State Street conducts on behalf of custody clients, according to the company's latest annual report.
State Street cited those inquiries in the section of the annual report it filed with the SEC on Monday regarding various risk factors State Street could face.
In its discussion of risks facing the company now, State Street's annual report said, “We expect that plaintiffs will seek to recover their share of all or a portion of the revenue that we have recorded from providing indirect foreign exchange services” — about $331 million for the year ended Dec. 31, about $336 million for the year ended Dec. 31, 2010, about $369 million for the year ended Dec. 31, 2009, and about $462 million for the year ended Dec. 31, 2008.

14 Feb '12

Oregon seeks to co-lead forex class action against BNY Mellon
The state of Oregon is seeking co-lead plaintiff status in a securities fraud class-action lawsuit against Bank of New York Mellon, confirmed James Sinks, spokesman for state Treasurer Ted Wheeler and the Oregon Investment Council, Tigard.
Oregon is seeking to recover a combined $15.7 million lost by the $57.3 billion Oregon Public Employees Retirement Fund, Salem, and the Oregon Common School Fund.
The $1.3 billion Louisiana Municipal Police Employees Retirement System, Baton Rouge, is also a plaintiff in the lawsuit.

18 Jan '12

Bank of New York Mellon settles forex lawsuit with feds
Bank of New York Mellon agreed to stop telling foreign-exchange customers that it is “getting the best execution prices” and to be more transparent as part of a partial settlement of a federal lawsuit, U.S. Attorney Preet Bharara announced Wednesday.

U.S. District Judge Lewis A. Kaplan approved the settlement on Wednesday, which originated from an October 2011 lawsuit that accused BNY Mellon of shortchanging its custodial customers by charging unfavorable forex rates.

The case revolved around transactions handled automatically by BNY Mellon on behalf of pension funds.

6 Oct '11

Analysis - BoNY FX Lawsuit a Red Flag for Public and Private Funds
“You’re basically letting the bank have free reign over what rate they will convert for you,” said Sahota. “So there should be no surprise that they are going to choose a rate that is more favorable to them than for the client. But rather than just raising the level of mistrust in the community, a best practice for funds would be to have ongoing monitoring and improve processes or directives to make sure that they are achieving better/fair execution on FX transactions. We audit everything else, why not FX?"

Read the full AFP article

5 Oct '11

Bank of New York Mellon accused of misleading clients on FX transactions
Bank of New York Mellon is being sued by New York federal and state prosecutors who accused the bank of cheating clients in foreign exchange transactions. Prosecutors accused the bank of promising clients the best available rate but instead giving them the worst or nearly the worst and then making a profit for itself from the price differential.

In two separate lawsuits seeking in excess of $2 billion, the Manhattan U.S. Attorney and the New York Attorney General alleged the bank misled clients about the method for determining what currency exchange rates it used for certain foreign exchange transactions.

11 Aug '11

Bank of New York sued by Florida over forex fees
Florida Attorney General Pamela Jo Bondi is suing Bank of New York Mellon, accusing it of breaching its fiduciary duty by overcharging the Florida Retirement System's $129.6 billion defined benefit plan millions of dollars for foreign exchange fees.

29 Jun '11

Treasurer raises claim of BNY Mellon overcharges to MassPRIM
Massachusetts Pension Reserves Investment Management Board, Boston, has been overcharged $30.5 million since 2000 on foreign-exchange transactions conducted by custody bank BNY Mellon, alleges state Treasurer Steven Grossman.

4 Apr '11

Banks' profits could take hit in fight over forex fees
The legal battle over fees for foreign exchange trading could hit the bottom line of global custody banks if public pension plans are successful in their civil suits., according to a report by Pension & Investment magazine.

15 Feb '11

Currency Charges Weren't Monitored
The Wall Street Journal is reporting that public pension funds have ramped up currency trading in the past decade but have failed for years to monitor prices banks charge in making these trades—and in one case, appeared to have ignored a consultant's warnings of being overcharged.

Those alleged failings, described in government and court documents and interviews with consultants and others, are coming to light amid an investigation by state attorneys general about whether banks overcharged some funds for currency transactions to facilitate global stock trades.

15 Feb '11

U.S. custody banks face fx profit margin squeeze
An article published by Reuters Financial news focuses on the the FX practices of Custodian banks. U.S. custody banks are grappling with more than just lawsuits targeting their foreign exchange practices. They also face a profit margin squeeze on lucrative currency trading as customers look for better deals. Trust banks such as State Street Corp and Bank of New York Mellon Corp make just under 10 percent of their revenue from foreign exchange, the buying and selling of currencies used for international stock transactions. Both State Street and BNY Mellon face lawsuits contending they overcharged public retirement funds in California, Virginia and other states. The banks deny wrongdoing and vow to defend themselves.

Whatever the outcome, analysts and industry observers point to increased customer scrutiny on pricing that is driving down margins in an area previously considered a safe haven for the custodians -- and one far more profitable than their bread-and-butter recordkeeping and account processing work.

27 Jan '11

Virginia Attorney General investigates foreign currency trades
Virginia Attorney Gen. Ken T.Cuccinelli II is alleging that a major New York financial institution defrauded the state's public pension fund by regularly overcharging for foreign currency trades. Cuccinelli this week intervened in a lawsuit brought by a private whistleblower that seeks $150 million in damages from the Bank of New York Mellon, which has served as the master custodian of the Virginia Retirement System since 1988.

The lawsuit, first filed in Fairfax County Circuit Court in October 2009 and unsealed by a judge on Monday, charges that since 2001 currency traders for the bank skimmed profits of transactions conducted on Virginia's behalf by falsely reporting the rate at which currency was exchanged.
According to the suit, the foreign exchange practices also involved Fairfax and Arlington counties' pension funds.

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