Whalen on CDOs, OBS, Fraud and Europe - I suggest you be very afraid

In 2006, after reading one of my friend Chris Whalen's articles in which he discussed the size and dangers of the Synthetic Collateralized Debt Obligation (CDO) market, I picked up the phone and rang him. "Chris, I have to admit that I simply do not understand what you've just written. Could you please explain it to me in small words?"

To his credit he did, and he took his time, and used small words, and at the end of our call, the only thing I could say was "Chris, based on what you've just taught me and what you are saying, you are now the scariest person I know."

Not long after came the collapse of Lehman Brothers and the slide into the Global Financial Crisis (GFC). Everything Chris had written seemed to come to fruition, as if he had written the play-book for the crisis, or at least the reasons for the processes creating the crisis.

Fast forward to 2017, and over the past two weeks Chris has again written two very alarming articles. Last week focusing on CDOs and OBS risk, while this week's article sheds light on why Europe should worry us.

Last week Chris wrote a piece, this time called "CDO Redux: Credit Spreads & Financial Fraud". Read this article from Chris. It is as scary as anything he wrote in 2006. Toward the end you'll find the following statement:

The fact that Citi, JPM and GS are now pushing back into the dangerous world of off-balance sheet (OBS) derivatives just illustrates the fact that the large banks cannot survive without cheating customers, creditors and shareholders.

He points out that the very largest banks, like retailers, cannot be profitable by selling a greater volume at a lose, but only by, in effect, cooking the books. This suggests that systemic fraud is part of the natural business cycle, and he seems to be saying that we are nearing the end of this cycle.

As we note in "Good Banks, Bad Banks," larger institutions suffer from a fatal lack of profitability that ultimately dooms them to commit fraud and, eventually, suffer a catastrophic systemic risk event.

How big is this problem? Chris has a nice chart. Sure, it looks like the problems were in the past, but look at the re-growth to today. Notional Off Balance-Sheet Derivatives (OBS) are, between the three largest (Citi, JPMorgan, and Goldman Sacks) over $140 Trillion, not far from the GFC peak of around $130 and a later peak of possibly $175 Trillion.

Now, I seem to remember that "OBS" - Off Balance-Sheet, is bad. I seem to remember that it was the Off Balance-Sheet manipulation via the use of Special Purpose Vehicles (SVPs) that distorted their true debt position, and lead to the crash of Enron in late 2001.

Imagine a bank for which a 30BP (Basis Points: 100 PB = 1%) move in the OBS book would wipe out the bank's capital. Imagine wiping out a bank's capital with a .07% move (7 basis points). Imagine any entity leveraged 8000:1.

Note too that the relatively small GS has a notional OBS derivatives book of more than $41 trillion, almost as large as that of Citi and JPM.  More alarming, a move of just 7bp in the smaller bank’s OBS derivatives exposures would wipe out the capital of Goldman’s subsidiary bank. This gives GS an effective leverage ratio vs its notional OBS derivatives exposures of 8,800 to 1.

Worried yet?

Jumping forward to this week, and he has nothing comforting to say about Europe (or again, the American situation). This the following is not a surprise, the clarity of statement leaves no doubt:

Zero rates and QE a la Yellen, Draghi and Abe is not about growth so much as it is about subsidizing debtors, especially governments and other public obligors who are beyond the point of recovery in terms of ability to repay debt.

Meanwhile we continue to see the Rape of Greece, with bailouts primarily intended to subsidize European banks and governments, with Germany seeming to take the lead. All this as European banks continue to record interest "income" against non-performing loans. Many of those loans will never be repaid, and a haircut is inevitable. Chris points out that "more public sector debt has been incurred and the banks – which admit to some €850 billion (6%) in non-performing loans – are essentially insolvent as a group."

The big question will be whether Cyprus becomes the model for Europe, and if so, how long can the banking sector survive a run, or at least a slow walk, on deposits by individual savers. So far, QE in Europe has been used to avoid this, but not forever.

Europe is drowning in debt and there are a number of large EU banks that are demonstrably insolvent.

This continued pretense by the Europeans, coupled with the CDO & OBS situation in the US points to two of the three major economic blocks (counting China & ROTW {Rest of the world} as the third) piling on higher and higher levels of systemic risk. And not matter what anyone says, it will not be different this time.

Chris is being scary again. and again, we should listen to him.

Reputation v Reality - Panama and Banking

Opening a bank account in a Tax Haven is supposed to be easy. All hush hush, sly winks, funny bank account numbers. Or as the British might say - "Nudge, nudge, wink, wink, say no more, say no more". I would not say that was my expectation when opening a bank account in Panama, but I certainly was not ready for the level of Customer Due Diligence, KYC (Know Your Customer) and AML (Anti-Money Laundering) checks that were required. And here I were thinking, I'll hand over some cash and we'll open a bank account.

Still the (new) bank insisted the checks they insisted on making were completely normal, and that there had been no change in their process. The printed and many-times photocopied forms certainly appeared to support their position.  This in contrast to my experience opening a bank account in the UK with nothing more than a Belgian identify card. I walked in, sat down, handed over my Belgian identify card and a letter from my employer (which, frankly, I could have typed and printed from my own computer). With little other than asking me for my address, I had a UK bank account, with a debit card in the mail.

At this stage let me say that this was all above-board, as we were in the process of actually moving to Panama from the UK. I'll also confess that this was a month after the world wide splash of the "Panama Papers" and the sudden spotlight that this had shown on Panama in general, and on banking and legal services in particular.

Opening a bank account is one great example of just how the stereotypes of Panama simply are not accurate. Not only did they require identification (and a Belgian identify card was not sufficient, thank you), they required a letter of introduction from our UK bank. A letter that could never touch my hands, but that had to be sent from Bank to Bank. Imagine the humor when I asked for a letter of introduction from my bank. The conversation went something like:

"I need a letter of introduction for my new bank."
"We don't usually issue those."
"This isn't a UK bank."
"Oh, okay, in what country?" said as the service representative was looking up the procedure online.
"Umm, Panama."
Big smile from the service representative "Really? Panama, like, the Papers?" Big smile.
"Yes, really. You didn't need one, but they do."
"Really?"
"Yes, really, and it must go directly from this bank to that bank."
"Oh, so I can't just print it and give it to you?"
“No, and it must be mailed to them, on UK bank’s letterhead, and from the bank’s office. I cannot touch the letter.”

There is little question that the Panama Papers scandal has been a trauma for the country and the legal and financial services industry. Regardless of how many times people are reminded that "offshore havens" are rife, and that certain US States effectively replicate the functions of offshore tax shelters and money laundering havens, the stigma now sticks to Panama. A recent estimate says that 10% of global GDP is held in "off-shore" havens. Trust me, that money is not in Panama.

The Panama Papers have already toppled the government of Iceland, and last month, the Prime Minister of Pakistan was dismissed by the Supreme Court on the grounds of corruption exposed by the papers. numerous politicians and celebrities have been exposed as having "businesses" in off-shore havens, not all in Panama, but all exposed by the release (hacked theft or internal theft, this still remains to be confirmed one way or the other) of files from Mossack Fonseca, a Panamanian law firm that operated in at least 9 countries at the time.

Multi-national corporations with regional headquarters in Panama have considered relocating, and at least one appears to be on the brink of doing so. While that organization does not have significant operations in Panama, it is the Latin America and Caribbean administrative hub.

Meanwhile, Panama has, over the past decade, maked real, tangible progress in the area of Corporate Governance, lead by the IGCP (Instituto de Gobierno Corporativo-Panamá) and various financial supervisory regulators, and the OECD. The first Corporate Governance Code was introduced in 2010, and is enshrined in the Corporate Law.

In relation to the effectiveness of banking supervision, in 2006 the IMF reported: "Panama is largely compliant with the majority of FATF Recommendations for anti-money laundering and countering the financing of terrorism (AML/CFT), reflecting the efforts of the authorities and industry to put in place an effective AML system. Nevertheless, staff makes several recommendations..." Panama has since updated its legislation in line with the IMF recommendations.

In the associated area of Risk Management, the Panamanian banking supervisor requires all banks to provide a statement that they have an effective system of Risk Management. Further, this statement must be signed by the Board of Directors. This is included in the detailed in Chapter IV of Rule 7-2014 (August 2014).

So while Panama has been making serious progress on corporate governance, anti-corruption and banking supervision for many years, still the country has a bad reputation. Having the previous president sitting in a US jail awaiting extradition for corruption does not help. Nor does a culture in which the police regularly request bribes, and in fact give lessons on how to pay those bribes.

Clearly there is a long way to go, both in actual implementation of effective corporate governance, and in inculcating a culture that rejects corruption at the grass-roots level as well as at the most senior levels of government. But the country is not the Wild West, and if anything can be learned from the Panama Papers, it is a reminder that reputation made in years, but destroyed in seconds. Panama has been spending the years demonstrating that it plays by the international rules, and in fact enshrines those rules in law.

Going through the processes of getting a bank letter of introduction was not the end of their due diligence. My employer in the UK received a telephone call from the bank in Panama. Do I actually exist, and do I really work for this company? Could they confirm by email please, from a company email address?

Remember that this is required by a bank in an off-shore tax haven. All I can do is quote the UK bank service representative: "Really?"

"The Zone" is more than just a place

Once upon a time there was a special place. So special, that the people of the land and country on both sides of the place were not allowed to go there, unless invited or to work. The only people who could live there were aliens from another land. And they brought that other land with them, right down to mowed lawns, schools and supermarkets, bowling alleys and cinemas. But only the aliens were allowed to send their sons and daughters to the schools, and only the aliens were allowed to shop in the stores. This special place, we'll call it "The Zone" contained the single most valuable national infrastructure asset in the country. An asset so huge and costly to build, that it became one of the single most important strategic assets of the aliens, and of the world; more important than almost any infrastructure asset in the aliens own land. Now imagine that this asset could generate, directly, or enable up to 20% of the country's GDP, if it could be exploited by the country it sat in. Imagine also that this asset could, but did not, generate a continual revenue stream to the national government, that could be used for development, roads, education, rural electrification, ports, healthcare systems, the list goes on.

Oil is one of the only natural resources that is able to generate that kind of benefit for a country, but then only if the global oil market is delivering a price point that exceeds the extraction and committed costs associated with that oil. But as oil is fungible and (relatively) plentiful, too often countries have created spending commitments based on a oil prices at their peak, and not at their trough or even average price. The price of oil jumps, then crashes, then crashes and jumps again, and now is relatively stable at a level below the cost of production for many countries that rely on oil revenues.

Imagine instead a resource that is limited, stable, non-fungible, with a clearly definable economic break even point for consumers and users of that resource. And where was that special resource? In "The Zone" of course, out of reach of the country in which it sits, and completely under the control of the aliens with their supermarkets and schools and mowed lawns.

To make matters worse, the aliens were giving it away! Access to the resource was mandated to be provided at an operating break even price, not at a economic break even price for the user of the resource. This means that the users effectively gained a massive windfall at the expense of the country. Restricted access to that infrastructure and asset, and the inability to influence the pricing of the asset (or use of the asset) and inability to access a revenue stream for the government, was holding back economic development of the rest of the country.

So economic development outside "The Zone" progressed at a crawl, with the host country unable to enter "The Zone" without permission, unable to set the price of the resource, and unable to economically benefit from that resource.

The Panama Canal is that resource, and it sits in the middle of "The Zone", a strip of land 10 miles wide, which since the end of 1999 is once again Panamanian national territory. Before the handover, the Panama Canal was mandated to run as a break-even proposition, owned by the United States government. As much at $10 million per year in profit could be provided to the Panamanian government, if the Canal ran a surplus. $10 million on annual revenues of $350 million is not a very good return on the asset, and this was the maximum that was authorized to be paid.

 

Panama Canal Revenue; 1980 - 1989

In 1989, the Panama Canal Authority had revenues of US$329 million. With inflation, that $329 million in 1989 would equate to $638 million in 2017 dollars. Current, 2016, Panama Canal revenue was $1,933 million, based on traffic volumes; total tonnage has almost doubled, while total transits remains comparable to 1989. So for decades, the equivalent of $1.3 billion in national revenue was effectively being distributed to shipping companies in the form of subsidized low-cost canal transits.

"Including the passage of neopanamax ships by the new locks, the Canal recorded between October 2015 and September 30th, a total of 13,114 transits and 330.7 million CP-UMS tons (volume measurement of the Universal Systems Tonnage of the Canal of Panama), said the official information."

Today "The Zone" remains, but is now Panamanian national territory, and while most of the land was converted into, and remains a national park, development does encroach.

Most importantly though, the Canal now runs as a profit making infrastructure, delivering over $1.5 Billion into the Panamanian treasury every year. In addition to the direct revenue to the Panamanian government, the very existence of the Canal creates and enables a massive logistics and transport industry, accounting for over 20% of the GDP of the country.

That increase in national revenue is remarkably stable. While traffic volumes fluctuate, the swings are in no way as wide, up or down, as the price of oil. Nor is the price of transit fungible. There is only one Canal, and the options are quite limited if you want to avoid rounding the South American continent, or if transporting across the North American continent by train is too expensive and time consuming. Therefore the Canal is able to price its service based on the economics of transporting goods by any other method or route. This creates a very steady revenue stream, and the country has been able to put that to good use for national infrastructure development.

There is a long way to go for Panama, and as with all developing countries, the challenges are huge, not least education, health, infrastructure and employment (although official employment figures are health with an official unemployment rate in the 4% - 5% range for a number of years). Corruption is rampant, and while Panama is a major offshore financial center, the "Panama Papers" scandal of 2016 dented its reputation.

If anything positive can be said about the 85 years during which the Canal was under US control, it is that the administrative and operational systems were put in place and a level of discipline inculcated that has carried over to Panamanian administration. The Canal is efficient, profitable, and well maintained, and functions as smoothly under Panamanian control as it did under American.

"The Zone" remains, but is now an artefact. But also remaining is the question of just how developed could this country be if it had access to price and profit from the Canal for the 100 years that it has been in operation, and not for the 17 years that it has been under the control of the country in which it is located.

Risk Managers in Uncertain times

Over the past few weeks I have been thinking about the world as we move into 2016. Most of that thinking is not about daisies and pixey dust, but about the changes over the past few years, many of which seem to be leading either to crisis, trouble, or the slow boiling of the frogs. Personally I'm hoping for a few crises that will, although probably fairly terrible at the time, actually bring about some fundamental changes that will create real change and improvement, at least in the medium term.


What's a Risk Manager to do? Below I contrast "the Usual Suspects" that we are (or should be) watching every day as Risk Managers, and then "the Big Stuff" and implications for Risk Managers now.

We are going to see the world change through 2016 and 2017, potentially dramatically - and not necessarily positive change. That is my view. Of course, I could be very wrong, and we could see a world that "muddles along". At heart are our individual answers to the question "how do we best help our businesses manage the coming risk world?"

I am not confident, but that is my view.

So let me suggest, based on my view, the potential impacts on Risk Managers for the coming couple of years. Two years is a very short time in a world of potential regulatory change and economic cycles. Anything shorter than two years would fail to consider the potential impact of major business and economic cycles such as the current commodity depression, the US (and China) manufacturing recession, and the very serious systemic debt and migrant issues that Europe may or may not manage through the coming year.

The Usual Suspects:

Of course the world of Risk will be both immediate and longer term, local or specific as well as systemic and international. We'll start by reminding ourselves of some basic risks that have no direct link to the wider situation.

1. Cyber threats. This category of risk continues to be on the rise, and can be an existential threat to companies from a data-loss or damage perspective, while civil and regulatory sanctions continue to increase. This is a threat that has been growing, and increased access and growth in skill sets will increase the number of hackers and the breadth of tools and techniques they will use. Companies will be taken down by Cyber attacks. Companies can prepare for and attempt to limit the impact of Cyber attacks, but can do little to reduce the likelihood of such attacks (as exogenous threat likelihood is not subject to risk reduction activities on the part of the company). Reducing the impact requires planning, careful review of the potential threat (what are the data-crown jewels, and how are these protected?) and remediation where infrastructure is not adequately protected. Reputation damage limitation if an element of planned responses, and finally, consideration should be given to Cyber Insurance.

2. Fraud, Bribery and Corruption. If the economy continues to grow and unemployment continues to fall, there will be little impact on the likelihood of Fraud, internal or external, though of course these risks remain. However, if we see a degradation in economic conditions, this will probably lead to an increase in fraudulent activity, starting with external fraud and followed by an uptick in potential internal fraud. Of course, some fraud, bribery or corruption is simply due to greedy people, and has no linkage to economics. Exercise skepticism.

3. Solvency. For the insurance industry in Europe, this is the year Solvency II fully comes into effect, and insurers across the continent are getting their reporting houses in order. Yet the risk is not simply that companies may or may not be solvent, it is a question of the quality of internal processes supporting production and maintenance of the ORSA (Own Risk and Solvency Assessment). As risk managers we can learn from companies that have been through the process, such as the importance of the quality of documentation of the process, effectiveness of systems of control (nothing new there), and the ability to demonstrate how the ORSA contributes directly to business decision-making.

4. All Your Risks. Every risk on your Risk Register will remain as critical (or otherwise) through 2016 and 2017 as they are today. Some will increase in potential impact, many will eventuate in actual issues or problems. These risks will become incidents, and you will manage them through to resolution - or not. There will also be a host of issues and incidents that will result in you reviewing the Risk Register, and probably adding risks to the Register.

You can never go wrong keeping your eyes on the day-to-day risks, and ensuring that the business either has effective controls in place, or is building a control environment that can actually be monitored to indicate areas of existing or emerging risk.

Now for the Big Stuff:

A global correction may be underway, with no sign of a low for some time to come. Certainly there may be up days or weeks, but it appears that there is more likelihood of a longer down trend for the coming months. The questions now are "how far, how fast, how long, and how much stimulus"? There are no serious commentators calling for a near-term renewal of a global bull market. The IMF recently downgraded their expectations for global growth from 3.8 (July 2015 forecast) to 3.4 (January 20016) with developed economy growth downgraded from 2.4 to 2.1, the same level as 2015.

The US markets are down 15% from their highs (DJIA - 15,900 from 18,200 in 2015), and China is at 2014 levels (Shanghai is at 2750 from a high of 5100 in 2015). [as at 26 January 2016]  Where will they go?

Total global debt has continued to rise all through the supposed deleveraging after the Global Financial Crisis (GFC), increasing by $(US)57 Trillion since 2007 to almost 200 $(US) Trillion. The majority of this increase has been government debt, yet corporate debt (and personal debt) has also risen through that period. This also cannot continue without impact.

At the same time in developed countries we see a close to stagnation in growth in real incomes. Personal income in the UK has finally (May 2015) caught up with where it was before the GFC, and the strong employment growth has been reflected in falling unemployment and increased wages. The introduction of a "living wage" will also increase personal incomes (although some worry that imposed minimum wages reduce employment growth). All good news, but will the UK continue to grow as the rest of the world slows down, if the UK votes to leave the EU, or if markets continue to fall (the FTSE is now at 5800 from just over 7000 in 2015, and continues to fall). [as at 26 January 2016]

In the US, employment growth appears to be strong, at the same time that the labor participation rate continues to fall. The unemployment rate is around 5%, a level that is close enough to full employment that we should be seeing serious upward pressure on wages. Yet the continued fall in labor participation indicates that there remains a (growing) untapped pool of labor. The picture remains murky.

Recommendations for Risk Managers

The current economic situation is, in my view, as scary as it has been since the GFC. Fear has an impact on risk and companies' and individuals' perceptions of appropriate levels of acceptable risk. How do we translate this into meaningful decision-making by companies, and counsel from Risk Managers?

1. Risk Appetite. There should be no better time than now to review (or write) the Risk Appetite for the business. Risk Appetite will provide a construct for decision-making by management that is in line with the level of risk that is acceptable to the Board and through them the shareholders. Risk Appetite is not a single statement, but needs to be broken into key business activities or processes, and potentially high level business units / companies. When reviewing (or writing) the Risk Appetite, speak directly with the directors and in private companies, with the key shareholders.

2. Identify your Key Risk Indicators (KRIs). These are the indicators whose movement provides insight into the potential increase or decrease in the likelihood of the materialization of any particular risk. For example, this may include items such as average days receivables (expanding may indicate deteriorating customer business conditions), or less obvious indicators such as unplanned staff turnover rates (with falling unplanned turnover being a surrogate for a degrading jobs market for your employees).

3. Stress tests (EKRIs). Build the models, and then test them beyond what your CFO/Finance Director thinks are possible. Build in extremes such as cost of fuel for distribution networks, cost of capital, internal project huddle rates. Stress until the model breaks, then look at why the model broke. That will give you a strong indication of the most important factors to be watching on a daily basis - your External Key Risk Indicators (EKRIs). I know of a very large manufacturing company that failed to hedge fuel costs, resulting in significant business costs when oil did spike. While that may not be the case today, if cheap oil turns out to be transitory, will cost-reduction based profits evaporate?

4. Outside-In. Having built or reviewed the Risk Register, the KRIs and the EKRIs, how are the risks identified reflected in the Risk Registers and risk reporting? Is the current risk environment too inward looking, focusing on the specific risks, controls, actions and people that are within the organization and therefore "observable" to management? How strong is the monitoring of external factors, and how can this be built into risk reporting?

5. Regulation Watch. Times of crisis almost always breed new regulation, or changes to existing regulation. I'm not going to opine on the benefits or otherwise of regulation, but as Risk Managers we must ensure that our organizations has fully considered the potential impact of such changes. When SOx (Sarbanes Oxley) and the section 404 requirements were passed, who predicted $170/hour for bulk standard Internal Auditors spending thousands of hours documenting mundane financial reporting processes and identifying controls - followed then by the massive increases in compliance costs to test those controls? Something like this is in our collective futures.

These are a few of the considerations for Risk Managers today. Are these different from what Risk Managers should be doing or concerned with in good times or steady global growth? No. And that is the rub, and the message; times like today provide strong reminders of what we should be doing every day. The increased fear do however provide us with the energy to get this done.

Governance; Ethics and Morals versus Regulation

In London at the CRSA Forum last week (25th March 2015), once again speakers talked about the importance of the ethical foundation of leaders and companies, and as usual rubbished the need for or importance of "rules based systems" of governance or regulation . Implicit in the comments was the importance of ethics as the foundation of any successful business. Explicit were the statements "ethics are better than regulation" and "rule based systems are less effective than moral or ethics based systems".

Unfortunately, that is bollocks. There is simply too much weight placed on the idea that ethics and morals actually deliver more effective governance than rules. On the one hand, absolutely, effective corporate (and personal) governance for long term benefit needs a moral and ethical foundation. On the other, remove the rules and only the ethical or moral will comply.

Rules do not exist to stop ethical behaviour, nor to make companies profitable or unprofitable, or to ensure that a manager "earns" a bonus. Rules and regulations are enacted by governments to promote what the government of the day has determined to be desirable behaviours, and to discourage or punish those that are undesirable.

While the good news is that only 4% of CEOs may be psychopaths (Forbes "Why some psychopaths make great CEOs") that is four times the average in society as a whole. And while only a small percentage of CEOs may be psychopaths, their CFOs and FDs are under pressures of their own to ensure the numbers are right. The penalties for missing the quarterly numbers can be decidedly unpleasant (CFO.com).

"Comply or Explain", the UK reporting mantra, is held up as the alternative to rules based systems of reporting and governance. IFRS is a wonderful example of principles based reporting, yet the IFRS (International Financial Reporting Standard) still runs to over 2700 pages, excluding various national GAAP extensions to IFRS. Still, this is better than the 17,000 pages of US GAAP (Moss Adams LLP, 2009). Yet anyone who has attempted to use IFRS will find that it is as mired in rules as any GAAP. This also overlooks that so much of US GAAP is based on permutations of tax law specific to the US or to individual states. Oh, and US GAAP has been around a little longer than IFRS.

A victory for principles based reporting? Or, as a friends says "If self-reporting was the only requirement, there would be no murder".

Rules exist for a reason. They provide the boundaries beyond which behaviours are unacceptable in law and regulation, if not in culture and society. Yet to point out that principles based systems are inadequate is all it takes to be branded in favour of a rules based system, as if that is something bad.

There are good rules, and there are bad rules. Don't eat your soup with a fork is a good rule. Allowing companies to discriminate against any minority based on the presumed religion of the company is NOT a good law (and is not religious freedom).

Allowing the CEO and Chairman to be the same person in a public company is not a good principle, but it would be a good rule. Because as a principle, it can be applied or not, it is only a principle. Make it a rule, and there is no weasling around it, it is worse than bad practice (and a fine indicator that the company is being run for the enrichment of the managers and now the owners) and it would not be permitted.

Independent directors are a sound principle, and I see no need for a rule on this. An independent Audit Committee chair is a very sound principle. So sound that maybe it should be a rule.

Board effectiveness reviews? Great principle, but no, I wouldn't make them mandatory.

After all, the purpose of rules is not to over-ride good principles, sound ethics and strong morals. The purpose of rules is to limit the flexibility of those that pay lip services to good principles, or those that are not ethical or moral. Fraudsters, or just those under pressure to produces the target numbers by any means, can more easily justify bending principles, but they cannot justify bending the rules.

Indeed, I continue to say "Principles and ethical standards only apply to principled and ethical people".