October 1, 2013

Custody Conundrum

Custodial banks are defending themselves against lawsuits over standing instructions on currency trades done during the clearing and settlement process

By By Mary Schroeder

Bank of New York Mellon Corp. last month appealed a decision by the New York State Supreme Court to allow a lawsuit brought by the New York State Attorney General against BNY Mellon over its foreign exchange trading.

In August, the state's highest court ruled in favor of the attorney general's office, allowing it to proceed with its lawsuit. New York's top cop is accusing the giant custodian bank of defrauding various New York City pension funds over a 10-year period by overcharging them for currency trades.

The appeal is the latest volley in a nearly four-year legal tussle between BNY Mellon and various states, as well as the U.S. Justice Department, over its "standing instructions" foreign exchange transactions service. Other custodian banks, including J.P. Morgan and State Street, have also been the subjects of FX-related lawsuits.

Jim Cochrane, ITG

Besides New York, BNY Mellon is facing lawsuits in California, Massachusetts, and Florida. It won a dismissal of a so-called whistleblower suit in Virginia. It also has had whistleblower suits thrown out in New York and California.

See Chart: Heading South

Custodian banks such as BNY Mellon take custody of the financial assets of institutional investors such as pension funds, including foreign securities. As part of that service, they may automatically enter into so-called standing instructions currency trades during the clearing and settlement process.

Standing instructions trades are typically smaller than negotiated trades, falling below the $1 million minimum necessary to qualify for trading in the inter-dealer wholesale market. The custodians' customers often don't learn of the actual prices of the trades until weeks after the fact.

BNY Mellon and State Street are the two largest custodian banks, as measured by assets in custody. Both do a significant amount of foreign exchange trading, typically acting as dealers in the trades.

PRICING

For the six months that ended June 30, BNY Mellon booked $328 million in FX trading revenues. Of that, $130 million, or 40 percent, was for standing instructions trades. The balance was for the larger negotiated trades.

In the same period, State Street booked $317 million in FX trading revenues. Of that, $150 million, or 47 percent, was for standing instructions trades. The balance was for the larger negotiated trades.

The New York State suit claims that BNY Mellon priced clients' FX transactions "at the worst rate at which the currency had traded during the trading day rather than at the market rate at the time of the trade. The bank then pocketed for itself the difference between the worst price of the day it had given clients and the market price existing at the time it executed the transaction. Through this fraud, it earned $2 billion over a 10-year period."