Rating agencies have wandered into the spotlight, again, after media reports revealed that S&P and Moody's will be quizzed over the collapse of MF Global.
Interestingly, according to letters obtained by the Financial Times (emphasis ours):
Moody’s Investors Service “did not have any understanding” that MF Global, the failed futures broker, had placed a $6.3 billion proprietary bet on the debt of troubled European sovereigns until about a week before the brokerage filed for bankruptcy, despite MF Global’s disclosure of the gamble some five months earlier in May.
The revelation, made in a letter by the agency to Congress obtained by the Financial Times, comes as US lawmakers plan this week to grill executives at Moody’s and rival Standard & Poor’s on what they knew and when ahead of the broker’s collapse on October 31.
According to a separate letter from S&P to Congress, dated January 17 and seen by the Financial Times, S&P participated in a conference call on August 31 with MF Global’s top executives at which the agency was told that the brokerage’s regulators required it to boost the amount of capital held against those bonds, a disclosure MF Global made the next day to investors.
Although there has been much debate over ratings agencies' role, after MF Global revealed a "surprise" announcement over it's sovereign debt holdings – which led to it filing for Chapter 11 only a few days later – Euromoney did highlight in November that the failed brokerage employed similar methods that Lehman Brothers used to hide its risk:
Experts have revealed to Euromoney that MF Global used the same methods as Lehman Brothers for disguising the amount of leverage it had, by using the repo markets.
This, in turn, has exposed the systemic risks in the short-term funding markets.
“There is this issue of debt masking out there,” one New York-based banker tells Euromoney. “One way banks can reduce the appearance of leverage is through the repo market. MF Global and Lehman Brothers both engaged in this activity to various degrees by getting the assets off the balance sheet and appearing to have less leverage around quarterly reporting time.”
When it became clear that the $6.3 billion sovereign debt position that brought down MF Global was collateralizing a repo trade, increased scrutiny of the short-term funding market seemed inevitable.
By treating the exposure as repo-to-maturity, the brokerage was able to treat the assets as off-balance sheet, an idiosyncrasy of the market that can be exploited by banks and brokerage houses when reporting quarterly figures.
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- Euromoney Skew Blog