By Katy Burne
Pacific Investment Management Co. in the past month pulled all
its futures-clearing business from a unit of State Street Corp.
after State Street asked Pimco to reduce some positions, said
people familiar with the matter.
The spat occurred as Pimco was grappling with the departure of
legendary bond investor Bill Gross and the billions of dollars of
investor cash that followed him out the door, the people said. It
wasn't clear if State Street's request was prompted by his
exit.
The shift affects a brokerage division within State Street
Global Markets LLC, which takes fees to handle derivatives trades
for financial institutions and asset managers in a process known as
clearing.
Pimco's withdrawal has led to an internal examination of State
Street's futures brokerage business, said one person familiar with
the matter. Pimco had planned to open several new futures execution
accounts with State Street, but those plans have been put on hold,
the people familiar with the matter said.
Some executives at State Street fear lasting damage to the
firm's broad relationship with Pimco, a giant asset manager in
Newport Beach, Calif., that oversees $1.87 trillion as part of
German insurer Allianz SE, the people close to the discussions
said.
The clash began when State Street determined in an internal
review that its unit had too much risk concentrated with Pimco. The
Boston company asked Pimco to reduce its positions, said people
familiar with the talks.
In response, Pimco moved all its positions from the State Street
futures-clearing division, said people familiar with the matter.
Executives at Pimco determined that if State Street wasn't able to
handle some of the business, it may be prudent to move all of it to
other brokers, one of those people said.
Some executives at Pimco believe the State Street action was
driven at least in part by recent discussions with the Federal
Reserve Bank of Boston, State Street's primary regulator, which led
the bank to be especially cautious regarding risk, said people
familiar with the firm.
A person familiar with State Street said it made the demands on
Pimco as a result of internal discussions, not conversations with
regulators.
Pimco's decision comes in the wake of investor outflows and poor
performance at its flagship Total Return fund in the year leading
up to co-founder Mr. Gross's departure.
Mr. Gross left Sept. 26 to join Janus Capital Group Inc. By the
end of the month the Total Return fund, which Mr. Gross had managed
since its inception in 1987, had lost $23.5 billion. Figures for
October have yet to be released.
Pimco's relationship with State Street extends beyond the
clearing unit, and the fracas could have larger ramifications for
the firm.
State Street specializes in administering assets for investment
managers and other financial institutions. It had $275 billion in
total assets at Sept. 30, with $28.5 trillion under custody and
administration for clients and $2.4 trillion overseen at its asset
management arm.
Its work spans almost every facet of Wall Street's business
,from custody services and securities lending to trading technology
and clearing. In the third quarter, its fees from asset servicing
and asset management were up 9% from the year-earlier period.
Clearing businesses such as State Street Global Markets are
commonly referred to as futures commission merchants, or FCMs, and
are regulated by the Commodity Futures Trading Commission.
The FCM at State Street Global Markets is small by industry
standards, having about $873 million in segregated customer assets
as of the last CFTC estimate in August. In disclosures relating to
CFTC rules for FCMs, State Street this year conceded it had unusual
client exposures.
"A significant portion of the FCM business of State Street
Global Markets LLC is concentrated with a small number of customer
accounts, which creates a degree of concentration risk...should an
adverse event occur," it said.
State Street said as of May 31, the unit carried more than 400
futures and cleared swaps customer accounts. More than half of the
margin it held in customer accounts for cleared swaps was
"attributable to a single customer account," it said.
Pimco has paid State Street to provide a range of services in
the past several years, including custody, accounting, valuations
and investment-management operations. In 2011, Pimco renewed a
mandate paying State Street to service $1.3 trillion of assets, a
book of business that dated back to 2000.
State Street's FCM also faces increasing costs of complying with
new regulations and hefty competition that often drives prices
below providers' costs.
In a November 2013 report, researcher Tabb Group said futures
commission merchants have "fallen over themselves to win" market
share and that the revenues associated with derivatives clearing
"look pretty grim."
Write to Katy Burne at katy.burne@wsj.com
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