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Comment for General CFTC Public Roundtable Discussion on Additional Customer Protections

  • From: James H. Gellert
    Rapid Ratings

    Comment No: 58346
    Date: 8/8/2012

    Comment Text:

    Rapid Ratings joins end users in the futures industry in welcoming the aggressive reform initiative that the CFTC has undertaken for the further protection of customer assets. After the calamities of MF Global and Peregrine, the need for new assurances looms large.

    However, maximizing the protection of customer assets will always be more than a matter of improving the logistics of an FCM’s cash management. Maximizing protection will always require a better understanding of the financial and operating climate under which the individual FCM conducts its business, because it is this climate that determines how strong the temptation becomes to ignore prudence and fiduciary responsibility in the first place.

    It remains to be seen exactly how far in advance of its bankruptcy filing MF Global began invading segregated funds. It may have been recurring or intermittent or non-existent before October 2011. But the melting away of MF Global’s revenue base over the course of the prior few years should have been an unmistakable sign of the growing tensions underlying its franchise. Likewise, a full understanding of the risk posture that MF Global assumed in acquiring and maintaining its gigantic European sovereign debt positions – positions familiar to the New York dealer community – could only have been achieved by reference to how precarious MF Global’s balance sheets and income statements had become before Governor Corzine even arrived there. The collateral requirements attending these aggressive new positions were formidable under the best of circumstances. The threat of a collateral emergency was likewise ever-present. Certainly anyone who knew of the trades and who read what Rapid Ratings had to say repeatedly about MF Global’s financial health also knew there was serious ongoing risk of downgrades elsewhere and large new collateral demands from repo counterparties as a consequence.

    Far worse than a year’s mad gamble in European sovereigns were Peregrine’s decades of willful theft and misrepresentation. Enabling the crime was the futures industry’s longstanding complacency in conducting business with privately held companies that offered customers and third parties little or no financial reporting on which serious judgments of creditworthiness could take place.

    Would Mr. Wasendorf have been as ready to invent financials if his customers had demanded full, audited balance sheets and income statements all along? Would Mr. Wasendorf have been able to compose such reports with sufficient skill as to withstand rigorous third-party examination over twenty years? Rapid Ratings recalls that, by applying large numbers of interrelated calculations to the published reports of Enron, our firm was able to detect vivid inefficiencies entirely inconsistent with the investment grade ratings that Enron enjoyed from the larger rating agencies – inefficiencies that later turned out to have been the result of commingling accurate and fabricated reporting lines.

    Service, relationship quality, direct access and other factors that have traditionally underlain the selection of an FCM are unlikely to remain sufficient for that purpose any longer. Today’s watchwords are transparency and viability. Rapid Ratings rates thousands of private firms in various industries on exactly the same metrics as we rate public companies. We are prepared to add any number of private FCMs to our present list of 70-plus public FCM-parents – if need be, we can rate these private firms without releasing their financials to the public. We have teamed with the Commodity Customer Coalition to deliver our judgments to its entire membership on a complimentary basis over the course of the next three months, as members adjust further to the FCM industry’s recent shocks.

    Coalition members will need to digest a wide range of Financial Health Ratings that we assign to the industry’s parent companies, all the way from 17-Very High Risk to 81-Low Risk, on a scale of zero to 100. (Note: MF Global was at 23 when it filed.) We expect that Coalition members will migrate to FCMs with higher parent ratings and away from FCMs with lower parent ratings – and certainly away from private FCMs that resist increased financial disclosure of the sort that futures customers now want for their own and third-party analysis.

    Effective reform of the futures market will be a matter of both improved rulemaking by the CFTC and developing Best Practices among market constituents. Deterring and detecting fraud and other malfeasances will be more than a matter of having sturdy new CFTC-mandated plumbing in place. These critical jobs also call for having sharp-eyed and independent inspectors on site, regularly examining each and every building connected to that plumbing and knowing where foundations are most vulnerable.

    Thank you,

    James H. Gellert
    CEO, Rapid Ratings International