Shocking! Big Global Custody Banks Don't Give Competitive FX Rates

Article: WSJ, Two States Go After Big Bank on Forex, Tom McGinty and Carrick Mollenkamp

An article in today's Wall Street Journal reports that two states --Virginia and Florida-- are suing their pension funds' custodian bank, BNY Mellon,  for applying unfairly disadvantageous rates to their foreign exchange executions.

Perhaps based on the custody agreement that they signed with BNY Mellon, the states are right, and should get some money back.  But I think there is a significant element of "buyer beware" in these types of transactions.  If you are running an internationally invested pension fund that converts millions of dollars on a regular basis, you need to make sure on a regular basis that you are getting competitive rates.  You need to negotiate and shop around until you get them--not accept your bank's daily rate because (perhaps) it is operationally convenient.

To me, using standing instructions with your global custodian to convert large amounts of funds "automatically" at their daily rate is like using the valet service at the Hyatt Hotel to do 30 pounds of laundry.  Everyone knows its a rip-off and a cash cow for the provider.  If you're in a pinch, let them wash one or two pairs of underwear for you, but unless you have money to burn, don't give them the whole sack.  OK, maybe this is not common knowledge, but if you are managing big money and hiring custodian banks it should be.

BNY Mellon is the largest of a handful of huge players in the global custody world (along with State Street, JP Morgan Chase and Citi).  They now have over $25 trillion in assets under custody.  Since the 1990's they have been at the forefront of what has been a massive shake-out in the global custody business -- small and middle-sized providers have all but disappeared as  BNY have used their "economies of scale" to aggressively lower their prices and either take clients, or buy competitors out wholesale.

data from BNY Mellon annual reports

But asset servicing (another word for custody) is not free.  It costs money to settle trades, to collect and record dividends, to wire money, to issue statements, to withhold taxes, to report to government regulators.  Clerks have to do most of this.  You can try to save money by cutting the number of clerks you hire and automating these processes as much as possible, but then you have to hire more skilled and expensive staff to do the automation, and to solve the messy problems that result when the automation doesn't work as expected.  

The fact is, by marking down their fees so aggressively (they average around 1 basis point or 0.01% of assets under custody), banks like BNY Mellon have put themselves in a situation where there is a constant hunger for costs reduction (ie, cutting heads) and revenue enhancement.  Foreign exchange has been an important revenue source for global custodian banks, at least since I first studied the topic back in the early 1990s.  They need the revenue, the same way that a bar that gives away free food needs to sell drinks.  No, their rates are not competitive, and their method of calculating them is not transparent.  But if you are an investor in international markets you should know what a fair rate is, and there is nothing stopping you from going out and negotiating your own forex deals, either with the custodian's own funds desk or with a different counter-party.

Now, whether BNY Mellon's rock bottom fees are an example of monopoly pricing is a completely different issue.