FX fee hike after Swiss move sparks execs' concern

Updated with correction

Consultants are advising asset owners to take a closer look at what they pay their global custodians for foreign-exchange trading after some banks responded to the increase in the value of the Swiss franc by hiking FX costs.

Such monitoring has been increasing since the rash of lawsuits beginning in 2009 against State Street Corp. and Bank of New York Mellon Corp. over improper prices for standing instruction transactions, those for which the timing and pricing of FX trades are left to the bank.

But the scrutiny heightened after the Swiss franc, often used as a global reserve currency because of its stability, became anything but stable on Jan. 15. That's when the Swiss National Bank removed its €1.20 cap on the franc, sending its value up by 40% against the euro and 30% against the U.S. dollar.

Consequently, sources said, some asset-owner clients of custodians State Street Corp. and Bank of New York Mellon Corp. were notified that costs would increase for FX trading on that currency as well as the Danish krone, which is now pegged directly to the euro but could run the risk of having that peg removed by the Danish National Bank because of the decline in the value of the euro.

Greg Fitchet, investment officer at the $2 billion Phoenix City Retirement System, said he understands the custodian's plight with more volatile currencies, but any continued increase in costs could have him look at other alternatives for FX. BNY Mellon is the Phoenix pension fund's custodian.

“I don't blame the banks,” Mr. Fitchet said. “I don't think they're trying to do anything untoward. But if costs go up, it's entirely possible we'd consider using an agency broker.”

Clients of BNY Mellon were notified in February that costs for deposits held in Swiss francs would increase to 175 basis points, from 100, and on March 1, BNY notified them that deposits in Danish krone would incur a 130 basis-point cost, from 90 previously.

BNY Mellon said the increase reflected market conditions. “Negative interest rates for these currencies are currently a market reality, and we have been charging in relation to those currencies for some time now as a result of central bank actions and market conditions,” said Joe Ailinger, BNY Mellon spokesman

Officials at State Street did not respond to repeated requests for comment.

The argument that more volatility in FX markets means higher trading costs for asset owners using standing instruction orders with their custodians isn't universally accepted. A pension fund investment officer who spoke on condition of anonymity said the cost increase over Swiss franc exchanges, although small, was an example of custodians “nickel-and-diming” their pension fund clients and has him looking into the use of agencies, or third parties, to execute his fund's FX trades.

“I agree, they are getting nickeled and dimed,” said Jim Cochrane, New York-based director at ITG Analytics, the trading and portfolio evaluation unit of Investment Technology Group Inc. “There are people out there that are taking advantage of the situation. And we're talking about pension funds here, people's retirement income. That's what amazes me; it really gets my goat. When (the FX cost increase) came up, my antenna came up. It proves the old saying about "buyer beware.'”

From an asset owner's perspective, it's hard to see where the changes in costs often come from, said John Halligan, president of Global Trading Analytics LLC, Rutherford, N.J. “It depends on the arrangement” asset owners have with their custodians, he said. “Do they have standing instruction or don't they, other fee arrangements, all sorts of things come into play. It's hard to tell what part is being affected” by the fee increase.

“But if you look at these guys (custodians), the good trading desks can take advantage of this” by increasing costs.

“Custodial fees are generally tight, so the appearance of nickel-and-diming is more upsetting to the asset owner. It speaks to a larger issue: the feeling among asset owners that there's not as much control in FX as they have in other markets. It's hard for an asset owner to get a handle on it all,” Mr. Halligan said.

Mr. Cochrane said the issue about whether an FX transaction is more costly isn't as dependent on the free float of currency as it is on whether there's a risk transfer involved in the exchange. “If custodial banks own the risk, the spreads widen and the trade is more costly. The banks own the hot potato,” he said.

“The issue for the Swiss franc was how quick the Swiss central bank acted and how much was lost when the bank pulled its support,” Mr. Cochrane said. “The banks were hurt when the Swiss acted. But with standing instruction, there's no promise of a rate, so there is no risk transfer. So the fee for trading, even with these currencies, shouldn't change.”

Other FX consultants understand the view of some asset owners, but still think custodians' moves over the franc were justified. “The risk associated with trading those securities has increased,” said Jimmy McGeehan, CEO and co-founder, FX Transparency, Framingham, Mass. He said the manner in which the Swiss National Bank stepped away from defending the franc “created some serious issues. Historical precedence had shown when a central bank of a convertible currency ... wished to remove support for a particular level they would simply adjust to a new level a few percent away. The fact the SNB chose not to clearly caught the market off guard. The magnitude and speed of the move was unprecedented, with markets moving more than 30% in a matter of minutes.”

ITG's Mr. Cochrane said the cost increase over the franc's rise was yet another reason for asset owners to monitor their FX costs. “At ITG, I heard a pension fund client say, "I work so hard on equity, I can't worry about FX.' Are you kidding? It's the same transaction, but you care more about the return than the FX exchange and the cost? We scratch our heads about this. Asset owners have more power, but they have to use it.”

Henry Yegerman, director of trading analytics and research at financial data provider Markit Group Ltd., New York, said asset owners thinking of going to agency brokers for FX trades should weigh the overall cost of using a third party vs. keeping FX trading under their custodians' purview.

“If you go to an agency, you'll get a lower price, but you have to do a lot more work. There's a hidden manpower cost (to asset owners). You've got to have someone who'll negotiate on the execution, someone to monitor the foreign exchange. It depends on the individual sponsor. Very often they have people already doing this, but if they need to add more responsibilities to them, that carries a cost.”