FX mispricing costs fund management industry dear
December 16, 2015

Mispriced foreign exchange (FX) transactions cost the European fund management industry and their underlying clients approximately EUR 1.5 billion per year, according to a paper published by The New City Initiative (NCI), a think tank representing the interests of asset managers.

The paper – The Changing Face of Foreign Exchange – estimates (conservatively it says) that US$590 billion of institutional investor FX transactions were at risk of being mispriced on a daily basis. As such, the paper highlighted how institutional investors and their fund managers have an obligation to ensure they are obtaining the best FX pricing and execution from their banks.

Custodian banks will often provide ancillary services such as FX pricing on behalf of clients and there have been concerns that a handful of banks have accrued significant or excessive profits from undertaking these transactions on behalf of institutions. Any custodian worth its salt will, though, deny the mere suggestion vigorously and convincingly.

Identifying these profits on a trade-by-trade basis has been challenging due to the lack of time-stamped trades. However, institutional investors are increasingly being given time-stamped data by custodians if requested. The paper also advised institutions utilize independent FX transaction cost analysis (TCA) during the investment process as a means by which to "improve trading strategies and practices and reduce trading costs."

Part of the FX challenge lies with the London 4.00pm FIX, which determines the benchmark rate based on trades taking place in a set time window. "Market activity around the FIX is irrational and generates a spike in volatility resulting in an increase in market spreads," notes the paper. "Trading FX at the London 4.00pm FIX is predominantly one directional skewing market pricing and adding a false premium to market pricing."





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Mispriced foreign exchange (FX) transactions cost the European fund management industry and their underlying clients approximately EUR 1.5 billion per year, according to a paper published by The New City Initiative (NCI), a think tank representing the interests of asset managers.

The paper – The Changing Face of Foreign Exchange – estimates (conservatively it says) that US$590 billion of institutional investor FX transactions were at risk of being mispriced on a daily basis. As such, the paper highlighted how institutional investors and their fund managers have an obligation to ensure they are obtaining the best FX pricing and execution from their banks.

Custodian banks will often provide ancillary services such as FX pricing on behalf of clients and there have been concerns that a handful of banks have accrued significant or excessive profits from undertaking these transactions on behalf of institutions. Any custodian worth its salt will, though, deny the mere suggestion vigorously and convincingly.

Identifying these profits on a trade-by-trade basis has been challenging due to the lack of time-stamped trades. However, institutional investors are increasingly being given time-stamped data by custodians if requested. The paper also advised institutions utilize independent FX transaction cost analysis (TCA) during the investment process as a means by which to "improve trading strategies and practices and reduce trading costs."

Part of the FX challenge lies with the London 4.00pm FIX, which determines the benchmark rate based on trades taking place in a set time window. "Market activity around the FIX is irrational and generates a spike in volatility resulting in an increase in market spreads," notes the paper. "Trading FX at the London 4.00pm FIX is predominantly one directional skewing market pricing and adding a false premium to market pricing."



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