FX Corporate TreasuryProprietaryCurrency Costs – The Trend Is Not Your Friend

February 2, 2011by John Galanek

In the financial markets there is a well-known phrase, “the trend is your friend until it ends.” One recent unfriendly trend has foreign exchange markets hoping for a happy ending: Three state pension funds have turned to legal means to address what they believe to be fraudulent FX pricing practices by banks:

  • October 2009. State of California, on behalf of CalPERS and CalSTRS, alleges fraud on currency trades handled by their custodian State Street Bank. California is seeking $200 million in damages.
  • October 2010. Washington State Investment Board reaches a settlement with State Street Bank for $11.7 million to settle a pricing dispute over FX transactions.
  • January 2011. Virginia’s Attorney General alleges that BNY Mellon defrauded several of Virginia’s pension funds by regularly overcharging for currency trades. The AG is seeking damages of $150 million.

Why does this matter for corporate treasury and finance professionals?

First, managing banking relationships (and hence monitoring the banks’ compensation) is one of the three primary responsibilities of the treasurer, as noted on page 19 in the Essentials of Treasury Management, 2nd Edition.

If you discovered that your banks made $4 million as a result of your currency activities last year, that is essential information to manage the overall banking relationship. If that $4 million turned out to have been exchanged at a cost of 15 basis points on average worse than the prevailing interbank rates on a forward-adjusted basis, you might have a very interesting discussion with your bank.

Second, this is not a tempest in a teacup. State Street Bank and BNY Mellon service roughly $45 trillion in assets, including ERISA pensions. This is an industry-wide issue.

Why does this problem exist?

Because of the structural impediments that exist in the institutional currency markets. Banks act as principal; they do not act as your company’s agent. In other words, they take the other side of your company’s trades and have economic incentive to give you the worst possible rate that you will accept. These lawsuits should provide a catalyst for treasurers to measure a cost most of them have yet to quantify.

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Cuccinelli Intervenes In Suit Alleging Pension Fraud - Wash. Post
States Widen Currency-Trade Probes - WSJ