Scrutiny of US forex trading shifts to private firms

The scrutiny of foreign currency trading in the United States is shifting to whether private investment firms, not just public pension funds, were overcharged by the banks that handle these lucrative transactions.

Money managers are handling more of these transactions in-house instead of relying on big custodial banks that traditionally took care of much of the business. The growing popularity of electronic trading tools, which have enhanced competition and transparency in the market, is hastening the shift away from custodian banks.

US states are stepping up probes into whether some banks overcharged public pension funds millions of dollars when converting currencies for securities trades. They are getting help from whistle-blowers, who have filed private lawsuits against Bank of New York Mellon Corp and State Street Corp. The two banks reject accusations of wrongdoing.

The Arkansas Teacher Retirement System sued State Street on Thursday, the latest pension fund to accuse trust banks of failing to give clients the best prices on foreign exchange trades.

In their lawsuits, the whistle-blowers focus on fraud against public pension funds because the laws reward exposing fraud against government entities.

But private, corporate customers of the custody banks could also have fallen victim to overcharges, said one person familiar with the whistle-blower allegations. The person spoke on condition of anonymity because of the ongoing investigations.

"Sophisticated private companies may have missed a beat or two here," this person said.

Asset managers, including BlackRock Inc have examined the rates they pay for foreign exchange transactions.

A review of BlackRock's trading practices as part of the "due diligence" for integrating Barclays Global Investors, which it bought from Barclays Plc in 2009, showed BGI got tighter spreads on foreign exchange trades with its custodial banks, said a person familiar with the review who was not authorized to speak about it publicly. Generally, the tighter the spread, the better the price on the trade.

Subsequently, BlackRock adopted BGI's forex trading systems more broadly, although it still trades forex in a multitude of ways due to various client requirements, the person said. The firm concluded nothing illegal occurred.

The issue may not affect all large investment companies, however, since many handle their foreign exchange trading internally.

"I believe the majority of the industry has moved on," said Mark Warms, a general manager of FXall in London. "Most are now more sophisticated and have sourced trading systems that give them access to multiple prices that are better suited to their requirements."

Vanguard, for example, said it has done its own foreign-exchange transactions since at least the 1990s and uses two platforms to try to get the best prices: FXconnect and Credit Suisse's AES. Through these two platforms they get access to dozens of market participants and thousands of traders, said Duane Kelly, a senior portfolio manager in Vanguard's international equity index group, adding that in-house trading allows the firm to have better control and oversight.

Legg Mason Inc and the MFS Investment Management unit of Canada's Sun Life Financial also said they do their own foreign exchange trading.

Fidelity said its trading desk, which trades for its own funds and some institutional portfolios, handles most of the firm's foreign exchange transactions. Some transactions go through custodian banks, but only a limited basis.

The fund company said in an email that it assesses "FX trading practices on an ongoing basis and, like others in the industry, we are monitoring information and allegations concerning custodian bank practices."

The lack of a central exchange in the $4 trillion-a-day foreign exchange market has made it difficult to obtain reliable price information. Investors have long complained about dealers hoarding pricing information in foreign exchange and other over-the-counter markets.

In a statement, BNY Mellon said it has several programs for customers to execute foreign exchange transactions. To describe its practices as overcharging "is simply wrong and ignores the substantial, cost-effective benefits and choices available to money managers and their clients."

Some fund managers may be reluctant to go public with their concerns, even if they know they have been overcharged. Many have turned to electronic trading to execute currency trades and then record the transaction with their custodian banks.

"Generally speaking, they are very quiet about what they are doing," said Harpal Sandhu, president and chief executive officer of Integral Development Corp.

"For one reason, they don't want to embarrass their custodian. Secondly, they don't want necessarily tell their investors that, previously, they were being cheated and now they have moved. This is very sensitive."