Hidden bank fee of the day, wholesale FX edition

By Felix Salmon
May 23, 2011
analysis of BNY Mellon's forex pricing, nicely summed up in this chart:

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The WSJ has done a great public service today with its analysis of BNY Mellon’s forex pricing, nicely summed up in this chart:

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Note the grey bars here, which are particularly egregious: a significant percentage of the time, BNY was giving its clients prices which were bad to the point at which they were physically impossible: no trades were actually done in the interbank market at that price that day.

This is about as cut-and-dried as things get. BNY Mellon’s clients put in FX orders, the bank executed those orders and reported back a price. Only it lied to its clients about the price it was getting, padding its own profits while so doing. This is doubly evil: not only did the bank lie, but it lied while serving as a fiduciary to its clients*, with an affirmative duty to give them “best execution.”

Watch the bank undercut a genuinely good point with an outright lie:

The spokesman says the bank offers “attractive, favorable rates” to pension funds like Los Angeles’s, which he says are not necessarily entitled to the interbank rate—the rate at which BNY Mellon trades. Many of the Los Angeles fund’s trades are relatively small ones, often of less than $100,000, he says. If executed in the international wire-transfer market, he said, the trades would cost the fund 2 percentage points above the interbank rate—a lot more than trading through BNY Mellon.

“Any suggestion that a price within (or even close to) the interbank range is an ‘unfavorable’ rate for these small trades reflects a fundamental misunderstanding of the foreign-exchange markets,” the bank said. The bank says it is transparent about the rates at which it executes client trades.

The fact is that small funds like the Los Angeles pension fund simply don’t have the wherewithal to get interbank pricing on their own. If you look at the total amount of money that the fund paid BNY Mellon for forex services, I daresay it’s quite reasonable compared to the alternatives. But one thing it’s not is transparent. BNY Mellon did not give its clients “the rates at which it executes client trades” — it gave them fake rates instead.

In fact, it’s far from clear that BNY Mellon actually “executed client trades” in any real sense at all. The obvious thing to do, if you’re a big money-center bank getting loads of order flow from thousands of clients around the country and the world, is to simply accept all orders and net them out internally, giving the sellers of dollars a rate at the top end of the daily interbank range, and the buyers of dollars a rate at the bottom end. That’s entirely consistent with what the WSJ is reporting, and it guarantees BNY Mellon a profit of the spread in between the two numbers.

If BNY Mellon did that transparently, it would probably be fine. But it doesn’t, and that’s the real problem here. It seems that even at the wholesale level, banks are much happier hiding their fees and profit sources than being transparent about them. Now BNY Mellon and other banks like State Street getting into trouble for its actions with state attorneys general and the SEC, maybe they’ll learn that honesty, in the long term, is a much better policy than trying to get one over on clients for whom you’re meant to be a fiduciary.

*Update: My colleague Cate Long says that BNY did not have a fiduciary duty.

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