Suits cause FX trading costs to plummet

Pension funds' costs for foreign-exchange trades by custodial banks have been slashed 50% or more, a direct result of legal action taken in recent years against the banks on charges they inflated prices.

“For many years, the average cost was nine or 10 basis points per trade,” said Michael DuCharme, senior currency strategist at Seattle-based Russell Investments, which runs its own FX trading desk but also advises institutional investors on trades. “It's about 50% of that now, about five basis points. It's a remarkable turnaround in fees, a great savings for investors.”

The foreign-exchange lawsuits involved so-called standing instruction trades, for which the timing — and therefore pricing — of trades is left to the custodian, according to James McGeehan, co-founder and CEO of FX Transparency, a Framingham, Mass.-based currency risk consultant. But now that the pension fund and custodian choose the time to execute the trade and “pre-agree” to the spread, the basis-point cost of each trade could be brought to the “mid-single digits,” he said.

“Many investors have switched to more transparent methods of execution with fixed execution times and transparent spreads,” Mr. McGeehan said.

The $25.9 billion Connecticut Retirement Plans & Trust Funds, Hartford, is “in the process of developing enhanced risk management activities that require periodic reporting of such fees and analysis of such trading,” said David Barrett, spokesman for state Treasurer Denise Nappier, the pension system's sole trustee. Bank of New York Mellon Corp. replaced State Street Corp. as the system's global custodian last month.

“The Office of the Treasurer's contract with our new custodian, BNY Mellon, does not specify FX rates. Each of our investment managers are responsible for seeking and achieving best execution on FX trades, similar to best execution obligations for commissions and other negotiable expenses,” Mr. Barrett said.

Lawsuits — starting with the 2009 lawsuit filed by then-California Attorney General Edmund G. Brown Jr. against State Street claiming the trading price charged the state's two giant pension funds was inflated — were the “big club” that hit pension fund executives over the head, causing them to look at their FX costs, Mr. DuCharme said. Those suits “provided a lot of motivation to look at fees,” he said. “It also caused banks to become more competitive in providing these services at a lower price.”

“Most plan sponsors had not looked at the costs of FX execution until 2009,” Mr. McGeehan added. ”The transaction costs can run a pension fund from one to 10 basis points of their total (assets). That's not a huge number, but at the end of the day it's a tremendous waste, potentially tens of millions (of dollars) annually, especially as investors can quite easily get those costs down significantly.”

An FX Transparency study of trade costs from 2000 through 2010 found a 63% decrease in transaction costs on custodian-handled standing instruction trades in the institutional market over the 12 months that followed the 2009 California lawsuit against State Street, without a resulting change in volatility, the key determinant of bid/ask spreads in the over-the-counter FX market, Mr. McGeehan said.

The California lawsuit, on behalf of the now-$274.8 billion California Public Employees' Retirement System and $171.9 billion California State Teachers' Retirement System, is still active in California Superior Court, said Nicholas Pacilio, spokesman for Kamala Harris, current attorney general. He would not elaborate, and officials at CalPERS and CalSTRS would not comment.

Other FX-pricing lawsuits are active, including those filed against BNY Mellon. The BNY Mellon actions include a suit filed by New York State Attorney General Eric Schneiderman, representing the $137 billion New York City Retirement Systems and one on behalf of the $13.1 billion Ohio Police & Fire Pension Fund and the $11.3 billion School Employees Retirement System of Ohio, both of Columbus.

Brian Murphy, partner at the law firm of Murray, Murphy, Moul & Basil LLP, Columbus, representing the Ohio pension funds, said no trial date is set, although “under our current schedule, trial would likely take place sometime in mid- to late 2015.” He would not comment on the existence or absence of any settlement talks, nor about changes in pricing that BNY Mellon has made with the pension funds. Officials from Mr. Schneiderman's office did not return calls for comment.

Several other cases were settled or dismissed.

Last month, Florida Attorney General Pam Bondi reached agreement with BNY Mellon on a $28 million settlement to be paid to the Florida State Board of Administration, Tallahassee. As part of that agreement, BNY Mellon will fully compensate the state for past FX trades and provide “complete transparency on the pricing of future trades,” according to the settlement. BNY Mellon on Oct. 1 was retained as FSBA's global master custodian for its $166.8 billion in assets. Whitney Ray, spokesman for Ms. Bondi, referred all questions to the FSBA. Dennis MacKee, FSBA spokesman, said the board has no comment on the settlement or FX pricing.

Another suit against BNY Mellon, filed by Virginia Attorney General Kenneth Cuccinelli on behalf of the $59.7 billion Virginia Retirement System, Richmond, and two other public plans in the state, was dismissed in November 2012 by a Fairfax County Circuit Court judge, and the Virginia pension plan renewed its contract with BNY Mellon for global custody, securities lending and foreign-exchange services for five years, with an additional five-year option. Jeanne Chenault, spokeswoman for the system, said Chief Investment Officer Ronald Schmitz would not comment.

State Street in late 2009 began providing more daily information to its standing instruction, or indirect, FX clients and their investment managers on the difference between the rates the firm sets and interbank market rates, said spokeswoman Alicia Curran Sweeney. “We continue to vigorously defend ourselves against the litigation. We offer clients and their investment managers a range of FX execution options, and we believe that indirect FX is chosen as an execution option when it represents the best mix of service and price to address their needs,” she said.

BNY Mellon “recently added to our FX trading product line with a defined spread standing instruction product that offers pricing based on objective rate sources, daily guaranteed rates and post transaction reporting,” said Kevin Heine, spokesman. Concerning the active lawsuits, “We view these issues as commercial matters and have taken a pragmatic approach to resolving them,” he said. “However, we will continue to defend ourselves in these lawsuits where appropriate.”

Other states, while not filing lawsuits, looked into how much their foreign-exchange trades cost. In a review by FX Transparency in 2011, the $53.9 billion Massachusetts Pension Reserves Investment Management board, Boston, found it had been paying more than seven times the median rate for currency trades on the repatriation of interest income, dividend income and tax reclaims, with at least $20 million in overcharges between January 2007 and May 2011 (Pensions & Investments, June 13, 2011). At the time, Massachusetts Treasurer Steven Grossman said he would use every tool at his disposal to recoup “significant” losses state pension fund participants suffered because of what he called “excessive” foreign-exchange trading fees levied by BNY Mellon, which has been MassPRIM's custodian since 1999 and continues in that role.

Eric Convey, spokesman for MassPRIM, said there is “no settlement with BNY Mellon to announce at this time.” He wouldn't comment further. Jon Carlisle, spokesman for Mr. Grossman, could not be reached for comment.

BNY Mellon, as global custodian for the Indiana Public Retirement System, Indianapolis, has “trade-specific” FX trading prices based on each transaction size, said Jodi O'Neill, spokeswoman for the $28 billion system. She said that was not the case with the system's previous custodians, J.P. Morgan Chase & Co. and Northern Trust Co., which were replaced in 2001 when the state's two defined benefit plans merged. Added Jeffrey Hutson, INPRS spokesman: “Fees for FX trades were agreed upon when we hired BNY Mellon as our global custodian two years ago, and they have not changed since.”

Although custodians are charging less for FX trades, it's still a profitable business for them, Russell's Mr. DuCharme said. “FX is a valuable service the banks provide,” he said. “It's lucrative, even at lower margins. The question (for investors) is: How much do you want to pay for it?” n