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Funds upping pressure to get best execution on FX trades

Steven Glass
Steven Glass thinks the responsibility for FX trades should lie with the manager.

(updated with correction)

Pension funds are focusing more on ways to reduce their foreign-exchange trading costs by negotiating better terms with their custodians — in the case of one public pension fund, bypassing the banks entirely — and requiring their money managers to get best execution on FX trades.

The move toward negotiating spot trades to settle FX conversions from using standing instruction, in which custody banks generally decide the timing and pricing of trades, began amid a spate of high-profile lawsuits. The suits, filed by pension funds against custody banks since the financial crisis, claimed the banks charged excessive fees for FX trades.

The latest lawsuit, filed Dec. 31 in U.S. District Court in New York, claims Bank of New York Mellon (BK) Corp. (BK) overpriced FX transactions on American depository receipts held by three pension plans compared with prices that were available in the market. The plaintiffs are the $18.3 billion Teamsters, Central States, Southeast and Southwest Areas Pension Plan, Rosemont, Ill.; $2.7 billion Verizon Savings and Security Plan for Mid-Atlantic Associates, Basking Ridge, N.J.; and $931 million Owens Corning Merged Retirement Plan, Toledo, Ohio. BNY Mellon, in an e-mailed statement at the time, said the suit is without merit.

However, sources said heightened pension fund interest in best execution and transparency in overall transaction costs has driven the shift, more so than the litigation.

“The best option is that the manager negotiates all FX trades. They're the fiduciary, they should have the responsibility,” said Steven Glass, president and CEO of Zeno Consulting Group LLC, Bethesda, Md., a transaction-cost analysis provider to pension funds.

Mr. Glass said RFPs from pension funds for custodial business are now more detailed in seeking FX trading pricing. Before the financial crisis, custodial banks often charged from 20 to 30 basis points for standing instruction FX trades. Now, banks are beginning pricing negotiations at 10 to 15 basis points and are willing to bring it down to keep or gain new business, he said.

One plan that requires all of its money managers to do negotiated trades is the $11.9 billion Los Angeles Water & Power Employees' Retirement Plan. Jeremy Wolfson, chief investment officer, said the move was made after lawsuits against custodians over excessive FX fees were first announced.

"Very opaque'

“The standing instruction process was very opaque until the recent investigation from many public pension plans,” said Mr. Wolfson, chief investment officer. “Upon further investigation (by the pension fund) and increased transparency, it was determined that the plan received, on average, the highest price for purchases and lowest price for sales,” although the prices were usually within the daily posted WM/Reuters benchmark rate.

“This poor execution was to the benefit of the custodian, and not the pension plan,” Mr. Wolfson said. “Investment managers were typically choosing to use this service for convenience or when they felt they didn't have the internal FX trading capabilities. With negotiated trades, we know that the investment manager, as a fiduciary, is obligated to obtain the best price available at the time of the trade.”

BNY Mellon was custodian at the time of the policy change, Mr. Wolfson said. Northern Trust Corp., Chicago, the pension fund's current custodian, has no say in the pension fund's policy; the plan applies its FX trading policy directly to its money managers.

BNY Mellon would not comment since the fund is no longer a client, Joseph Ailinger Jr., spokesman, said in an e-mail. Tim Hacker, Northern Trust spokesman, said the firm declined comment.

Los Angeles Water & Power's policy requires all of its separate account managers “to negotiate FX trades on behalf of the plan to obtain best execution at the time of the trade,” Mr. Wolfson said. “The only exception to this policy is for odd lots, and for restricted pairs that require subcustodial trades in certain countries that require this. This policy is hard-coded into a provision in each investment manager's contract, and is an explicit contractual obligation.” Zeno is the pension fund's transaction-cost analysis provider.

Mr. Glass said Los Angeles Water & Power, with its negotiated trade policy, is atypical of most pension plans. “Very few pension funds” do what Mr. Wolfson is doing, Mr. Glass said.

But that might be changing. “I'd say in the past year, we've had three or four conversations with pension funds about this; in the years before that, maybe one a year,” Mr. Glass said. “It's not that there isn't an interest. It's just that custodial agreements don't come up regularly. Changing a custodian is a big deal administratively and operationally for a pension fund. So it's more a timing issue.”

Added Peter Weiler, executive vice president at Abel/Noser Corp., a New York-based agency brokerbroker and transaction cost analysis provider for asset owners: “The overall trend is toward more transparency. Many (asset owners) had seen fixed fees go up. Pension funds aren't comfortable with a non-transparent model. The headlines (involving lawsuits against custodial banks) brought it to light; pension funds want to stay out of that world.”

Pension funds are benchmarking their FX trading costs by monitoring the costs of their peers, Mr. Weiler said. “No. 1, what are the absolute costs of FX trading and what are those costs vs. peers,” he said. “On the same currency trade, with the same size, what was the notional value and what was the price movement; basically, what did other investors do on the same trade.” He said such benchmarking is being done both for negotiated and standing instruction trades.

Attention to transaction costs for FX requires disciplined oversight from asset owners, something different from the late 2000s when custodian banks were conducting FX trades with little monitoring.

“There's nothing wrong with standing instruction foreign exchange unless you're not managing it,” said James Economides, director for Amaces Inc., a Park City, Utah, custodial consultant to institutional investors. “If you're aware of what's going on, you'll be comfortable with it.”

Mr. Economides said oversight doesn't mean the pension funds should handle FX trades themselves. “Asset owners who say they'll get involved in FX flows really make very little sense,” he said. “What they really should do is make sure the plumbing works. They need to look closely at their fund managers. Pension funds should really be interested in how their managers handle FX.”

This article originally appeared in the April 4, 2016 print issue as, "Funds upping pressure to get best execution on FX trades".