Foreign exchange: State Street’s FX loss might be TCA’s gain
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Foreign exchange: State Street’s FX loss might be TCA’s gain

Custodian banks under fire for overcharging; Scandal spurs interest in transaction cost analysis

The past few years have been difficult for custody banks. Lawsuits and bad headlines have put them in uncomfortable position, and now, for State Street and Bank of New York Mellon, the scrutiny has intensified. It was revealed last month that the US SEC had begun investigating them over their pricing of some foreign exchange services.

The SEC, State Attorneys General and US Attorney’s offices "have made enquiries or issued subpoenas concerning foreign exchange pricing," the Boston-based State Street said in a regulatory filing, made public on May 9. State Street said it would cooperate fully with the SEC in its enquiry, and would continue to defend itself against any allegations of wrongdoing.

It is a fall from grace. For State Street, the trouble began in December 2009, when the State of California, on behalf of its pension funds, CaLPERS and CalSTRS, alleged fraud on currency trades handled by the custodian bank, and sought $200 million in damages. Since then, three US state pension funds have taken their custody banks, also including Bank of New York Mellon, to court and at least two more are conducting investigations into whether or not they were overcharged for trades.

State Street suffers real money exodus
US client base takes battering
State Street’s ranking






 North America









Source: Euromoney Market Data

Scandal This year’s Euromoney FX survey suggests that these scandals have taken their toll on State Street’s real-money franchise. Its global ranking for real-money clients has slumped from seventh to 15th in 12 months. Bank of New York Mellon fell four places to 35th. For State Street, its North American business has been hardest hit; it has dropped to 13th from third among real-money clients, equating to a more than four-fold drop in its market share. In Europe and Asia its market share has also slumped, but not to the same degree.

When asked to respond to the survey results, State Street didn’t have anyone available to speak to Euromoney. However, State Street’s woes signal a change in the maturity of the market as investors become savvier about analysing whether or not they’re getting a good deal from their FX banks. Money managers are taking a lesson from equity markets and employing transaction cost analysis (TCA). There are big benefits from TCA, claim two leaders: Credit Suisse and Morgan Stanley. Credit Suisse provides an example of how one client reduced FX costs by more than 75% using TCA. Morgan Stanley says that for an asset manager doing $200 billion of FX executions, transaction costs can be cut in half, from an average $95 million to $48 million.

TCA might be a familiar word bandied around by banks and consultants but many of them offer only benchmarking, which compares transaction costs between the same client peer group; as such it offers no insight into whether it was a good price or a bad price.


Nick Greenland, global head of GFX client risk advisory at Credit Suisse, says there has been a marked rise in interest in TCA from clients. To improve its service, Credit Suisse has invested in tick databases that warehouse market prices from exchanges such as EBS and Reuters, capturing all currencies, all tenors, from G10 to non-deliverable forwards and restricted currencies.

"TCA will be hugely important in the next three to five years. It will become important across all fixed-income markets as it goes electronic the way FX has"

Jeremy Smart, Morgan Stanley

Greenland says the initial task of TCA is to reduce costs through spread reduction. For instance, a custodian might have charged a 10-pip spread for a currency transaction in the past; TCA can identify that they might have got two pips. The second task of cost reduction is through transaction netting. If a client is trading in an inefficient way, for example, by crossing multiple bid-offer spreads, TCA can quantify that.

"We believe we’re the only firm that can slice and dice data in any and every which way, from spot to forwards to NDFs and onshore restricted currencies," says Greenland.

Morgan Stanley also sees an opportunity for its e-commerce platform. Last year the firm established its quantitative solutions and innovations (QSI) group, looking at traditional TCA techniques and FX algorithms to encourage use of its electronic platform, Matrix.


"Many clients might say: ‘I can start using this algorithm, because conceptually I believe that it can reduce my transaction costs’, but they can’t prove it. What we’re trying to do is prove it for them," says Jeremy Smart, chief operating officer for fixed income and currencies at Morgan Stanley.

Morgan Stanley admits that the launch of QSI has been "unbelievable timing" given the furore that has surrounded the custodian banks, and it has not missed a beat. The firm has hired two people in London and two more in New York, under the leadership of Pete Eggleston, formerly of Royal Bank of Scotland. In six months the team has made 1,100 client visits, which equates to an average of almost nine meetings a day.

"TCA will be hugely important in the next three to five years. It will become important across all fixed-income markets as it goes electronic the way FX has," says Smart. And it has pretty broad appeal, according to Credit Suisse. "The interest in TCA and potential for cost savings we see are truly global and across the whole client base, ie, pension funds, asset managers, hedge funds, funds of funds, insurance companies and even other banks," says Greenland.

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