Direct and in many cases very significant financial benefit can accrue to pension funds and investment managers that pay closer attention to their foreign exchange (FX) trades.
UK-based benchmarking firm Amaces has launched a new module in its CMS analytical and benchmarking service that covers all FX deals. The module was launched in response to clients’ better understanding of the financial implications of the small value FX trades that are analysed as part of the CMS Custody and Treasury module.
CMS was developed as an objective analytical tool to help pension funds and investment managers determine how the service and value for money they receive from their custodians or third parties compares with their peers or the overall universe of users. Amaces believes that only through comparisons with peers and the experiences of other client types can problems be identified and remedied.
The analysis of small value FX deals in the custody and treasury module suggested that there was some abuse in terms of the spreads clients were being charged by their custodians. It is difficult for any client to track spreads and to determine whether the spreads they are getting are reasonable.
If problems were occurring with the small value deals, what was happening with the large FX deals? Amaces therefore decided to launch the FX module, a wider ranging version of the FX analysis that is in the custody and treasury module.
The new module measures all FX transactions irrespective of size and tenor. The reporting is very flexible and can be customised by the client to show performance by manager, counterparty, size of deals and currency cross types. The analysis will allow benchmarking to FX market rates as well as the FX experience of other clients and the client’s own peer group. The delivery channel will be the established Amaces secure website with its report writing facilities.
The latest CMS analysis has shown that in terms of weighted average normalised FX rate, the best client experience was 96, the worst 124. With this measure, FX deals that are done by the custodian under standing instructions are compared to the trading high and low of that day. These are normalised around 100 – the best a client might expect would be 90, the worst a high of 110. Individual deals are then weighted by value, giving the weighted average rate. Anything above 110 is too high, says Aidan Dennis, one of the founders of Amaces.
Amaces clients are using the FX module for a variety of reasons. Some pension funds are using it to check how fund managers that are using both custodians and other FX counterparties are performing. CMS enables them to compare not only with the market, but also with other pension fund managers and the counterparties they use.
One fund manager of a pension fund has delegated all transactional FX to the custodian; it uses CMS to ensure that it is being given reasonable prices. Another fund manager wanted to handle all FX trades itself except for certain minor and exotic currencies, which it handed over to its custodian to execute. By doing so, the fund manager gained greater operational efficiency in handling FX trades while the custodian received order flow. The fund manager, and its underlying pension fund client, can also gain an objective view of the competitiveness of the spreads they are receiving.
While the FX module enables clients to analyse better and monitor their performance, it is also playing a role in proving best execution. The analysis will enable pension fund managers to prove they have a process in place that monitors service quality and the financial performance of the fund.
The April data, produced by Amaces, which includes data from both the custody and treasury module and the FX module, show there are continuing breaks in the settlement process. The worst performance showed that 21% of monthly trades by value were settled late. The value of late income as a percentage of monthly income was 24% in the worst-case scenario.
Custodians will, of course, earn a spread on cash accounts, but as Dennis points up, if a pension fund is earning 0.11% on euro and the best in the market is almost 2% better – as was indicated in its quarterly figures to April 2006 – the fund should contact its custodian and find out why.
Amaces has more than 70 clients, 58 of whom use the custody and treasury service, of which 28 are pension funds.

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