On January 21, 2009, the long-awaited completion of the restructuring Plan affecting $32 billion of third-party ABCP (asset-backed commercial paper) was completed. Under the Plan, certain holders of affected ABCP have had their short-term commercial paper exchanged for longer-term notes of various issuers. The consequences of completing the Plan restructuring in terms of market liquidity and recovery of value by holders of ABCP remains to be seen and will be determined by financial markets going forward. Future markets will also determine whether practices and expectations change on other subjects closely related to ABCP, such as product development, credit assessment and the basis on which liquidity lines of credit will be made available. However, the Plan was very specific regarding one future development, being the liability of certain persons, including issuers, financial institutions and product distributors. This aspect of the Plan was controversial, and the terms of the Plan include releases and injunctions with respect to many bases of liability – except those initiated by regulatory authorities and SROs such as the Investment Industry Regulatory Organization of Canada (IIROC).

The foregoing exception for continuing regulatory action and potential sanctions against those persons responsible for the ABCP debacle has two important aspects. First, it is expected that regulatory review and proceedings in respect of the activities of some of the market participants responsible for ABCP products will now proceed. Second is the prospect that public attention will be turned to the regulatory process itself, including the role of the Office of the Superintendent of Financial Institutions of Canada (OSFI), members of the Canadian Securities Administrators and securities industry regulators such as the IIROC.

With respect to the first aspect, possible enforcement proceedings by regulators, the Canadian Securities Administrators and the IIROC both issued studies or papers in October 2008 reviewing the history and problems that arose with respect to ABCP products in Canada. In addition, the OSFI has made certain public pronouncements on the matter. However, the IIROC has (wisely in our view) deferred the commencement of any proceedings until the restructuring Plan was completed, and the CSA has indicated it will work with the IIROC to address matters affecting ABCP purchasers that arise from IIROC enforcement proceedings.

The broader-reaching and potentially more important result of the ABCP crisis will be the second aspect of the role of Canada’s financial and securities regulatory regime in the development of the ABCP market and its response to the failures and losses that have occurred. Canada’s regulators will not be alone in receiving scrutiny, as the fallout from the worldwide credit crunch and financial market dislocation has resulted in serious losses to investors in respect of products similar to ABCP. Although Canadian ABCP had its own distinct features that may have exacerbated the commercial paper freeze in Canada, the use of highly complex, synthetic and opaque financial instruments was a common feature in many jurisdictions. For example, the failure of Lehman Brothers in the fall of 2008 left Southeast Asian investors holding billions of dollars of essentially worthless mini bonds that had many of the same derivative features of ABCP.

Whatever the judgments and proposals are with respect to Canadian regulators as a result of ABCP, one obvious observation may be made: the basis on which the complex ABCP products were developed strained the existing regulatory tools and resources of Canadian regulators. There is always some lag in the response of regulators to market developments (which is inevitable and in some respects healthy), but it is apparent that the substantive regulatory requirements that were in place were inadequate. This is not a criticism of the regulators, but more an illustration of the fact that it is impossible for regulation to keep up with specific product and distribution changes in global financial markets. In particular, prescriptive rules relating to products and market practices will likely never in themselves be adequate to address concerns that arise. For instance, market participants continually seek to structure products to minimize the effect of prescriptive regulatory requirements, such as the availability of exemptions, compliance standards for certain customer relationships and prudential requirements. This fact should lead to greater reliance on the principle-based approach to regulation by which financial products and market practices can be judged against broader standards of fairness, suitability and prudence. While the principle-based regulatory approach should not completely replace prescriptive regulation, the need for greater emphasis on this approach is growing in acceptance. The recommendations in January 2009 of the Expert Panel on Securities Regulation for Canada, for example, include enhancement of securities regulation by greater reliance on principle-based regulation.