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:


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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But don’t OTC markets like FX do, well, precisely that? That is, quote a price to retail or institutional customers that’s not as good as they could get in the interbank market, precisely because we’re not trading in units of millions there. I don’t think there’s the concept of “best execution” in FX.

Posted by patrick_bateman | Report as abusive

I’m shocked, shocked that banks make profits by making markets. Um, Felix, I used to trade currencies in a small African country. We had to pay for our terminals, our electricity, and the people who came to clean the bathroom. We took a spread–1%, 2%, 3%–based on the client’s credit, whenever we traded currencies.

When forex settled, we would wire the money blindly to the counterparty, and pray that they would wire the amount we were due back. That was “clean risk,” a credit exposure. Nasty, hairy stuff. All around the world, with all kinds of counterparties, in Japan, Hong Kong, Africa, Europe.

And we had to hold capital against it. So, I was supposed to make markets against odd-lot players and quote them the round-lot price, because Reuters was giving away terminals? Not!

My clients were free to price my offering against the competition. And never, Never, NEVER did I discuss my offering price with my competitor. Even if I were so inclined, there would not be time.

FX is an OTC market. Very competitive, very fast. And the poor pension fund managers couldn’t be bothered to check the bid away? Please. The real scandal is that they charged a management fee for their crappy performance, not that the bank made money on a spread.

BTW, I’m with a small asset manager now. Too small to compete for a big bad pension fund like LA’s. Because the consultants never consider execution, just structure. And size. Bigger is always better. Again: not. Who was the manager? And who was the consultant who recommended them? Now there’s a story!

Posted by Publius | Report as abusive

I don’t think that WSJ link is correct.

Posted by BarryKelly | Report as abusive

Its not obvious to me by how much the complainant was overcharged. BONY’s opaque pricing methodology doesn’t surprise me. But why is the complainant NOT executing their trades via Hotspot, EBS, Currenex or Reuters? (Hotspot provides excellent fills on odd-lots.) In other words, is the cost of do-it-yourself fx-trading via the ECNs greater than the all-in costs charged by banks like BONY? I’d guess no, which leads me to wonder: why does any institutional fx trader use a bank instead of an ecn for their executions?

Posted by dedalus | Report as abusive

People pay 10% above the self serve price for gas all the time when they dont want to do the work.

The gray prices are not “impossible”. When a small client trades a small amount at a weird time of day they get the IB rate plus a spread. Easy to make that outside of the days range.

The pension funds “should” care. They should check rates. THey should ask for a better deal. Or an indexed rate or banchmark rate, all commonly available.

This is exposing the “easy” and expensive way.

he WSJ inflated the typical deal size to make a point. These deal sizes are small.

Posted by busterC | Report as abusive

Should the LA Pension fund be trading FX? Do they hire FX traders? Do theyu do any due diligence. When they get any OTC product from any bank, they get spread wide like canyons.

Posted by busterC | Report as abusive

Orannge County, anyone?

Posted by busterC | Report as abusive

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