Foreign Exchange Best Practice
Case Study
Issue
Institutional pension funds identified that their global custodians were applying significant markups on fx rates for trade settlement and turned to the manager for assistance to correct the situation. The impact of the excess markups increased the cost of securities purchased and reduced the amount received from sale proceeds, all of which had a knock-on effect on account performance.
Challenges
There were 2 primary challenges that the manager faced. The manager lacked authority over the 5 global custodians in question. The clients maintained the contractual relationship with each custodian and as such it was the clients who had the power to influence the custodians, not the manager. Most, but not all, custodians understood that the manager served as a proxy for each client. Also, each custodian had a different structure to its standing instruction FX platform. This platform covered other bank clients and was not seen as being easily modified for this exercise.
Process and Approach
The manager decided that rather than dictate specific terms for each custodian to follow, it would develop a set of best practices that would lead in the direction of the what the manager and clients wanted while being able to operate within each custodian’s platform. The manager also understood that the best practices were guidelines and not all practices would be adopted by all custodians. The manager initially met with each custodian to understand their process. These processes then served as the framework for the best practices which were then shared with all custodians who were urged to adopt them. Clients were kept up to date throughout the process.
Result
The overall results were good and many of the practices were adopted my nearly all custodians with one custodian rejecting the entre exercise. The main themes of the best practice were:
- Rate Transparency using timestamps, benchmark rates, and defined spreads
- Competitive Pricing for restricted currencies
- Structural Features of the program in the form of netting points and price collars