A lawsuit alleging State Street Corp. overcharged high-profile custody clients for currency trading services could prompt institutional investors to focus more on how much money they're leaving on the table as the non-U.S. portion of their portfolios continues to climb.
While unlikely to prove a major headache for State Street, the suit could shine a spotlight on foreign-exchange trading costs, with potential long-term ripple effects for custodial banks in general, investment consultants say.
The suit was filed Oct. 20 by California Attorney General Edmund G. Brown on behalf of the country's two biggest pension funds: the $201.1 billion California Public Employees' Retirement System and the $126.9 billion California State Teachers' Retirement System.
The huge windfall custodial banks reap from foreign exchange trading is one of the industry's worst kept secrets, and the potential cost savings for pension funds from greater due diligence in that area are great, said Cynthia Steer, chief research strategist with Darien, Conn.-based investment consultant Rogerscasey Inc.
According to U.S. government data, currency trading has been, on average, the richest source of trading revenue for U. S. banks over the past 12 years, accounting for $2.1 billion of the $5.2 billion total trading revenue in the second quarter of 2009, and $11.4 billion in revenue for all of 2008, when total trading revenue was -$836 million.
A recent study by TABB Group, a Westborough, Mass.-based financial markets research and strategic advisory firm, found that almost three-fifths of buy-side foreign-exchange desks measure foreign-exchange trading costs. But some market veterans say that figure is optimistic.
There's evidence to suggest that as much as “95% of institutional investors don't quantify their current trading costs,” said John B. Galanek, a managing partner with FX Transparency LLC, Framingham, Mass., which aims to help investors quantify and reduce those costs.
Mr. Galanek was senior vice president of foreign exchange with Harvard Management Co., Boston, where he managed currency execution for Harvard's endowment fund. He and fellow managing partner James McGeehan launched FX Transparency this year, anticipating a growing number of institutional investors looking to better control their foreign-exchange trading costs.
That would be a long overdue development, argues Rogerscasey's Ms. Steer.