Much has been written, and much will continue to be written, about Canada’s experience with asset-backed commercial paper (ABCP), which became a recognizable acronym in August 2007. At that time, the market for ABCP froze as a result of the unwillingness of the market to roll over third-party, non-bank-sponsored ABCP and the refusal of liquidity providers to interpret their liquidity obligations as having been triggered as a result. These liquidity providers had agreed to provide so-called “Canadian-style liquidity agreements” that would be triggered only by a “general market disruption,” and not by an event affecting only a particular issuer of ABCP. Thereupon, a number of market participants, including asset providers, liquidity providers, note holders and other financial industry representatives, entered into a standstill agreement. Known as the Montréal Protocol, the agreement is a commitment to restructure the third-party ABCP market with a view to preserving value for the holders of third-party ABCP.
The frozen non-bank-sponsored ABCP was made the subject of a restructuring proposal under the Companies’ Creditors Arrangement Act (CCAA), which the Ontario Superior approved as a restructuring plan on June 5, 2008. The Ontario Court of Appeal dismissed an appeal from that approval on August 18, 2008, and the Supreme Court of Canada denied leave to appeal from the two lower court decisions on September 19, 2008. For a commentary on the CCAA proceedings, see this article.
Bank-sponsored ABCP issuers were able to continue rolling over their paper with minimal disruption as the bank sponsors bought back much of the ABCP from their related conduits and brought significant amounts of the ABCP back onto their own balance sheets.
DBRS Ltd. was the only rating agency that reviewed and rated ABCP issued in Canada. Initially, it did not distinguish between banksponsored and third-party conduits. In January 2007, DBRS announced that it would no longer give high ratings to ABCP structures backed by “general market disruption” liquidity lines.
Among the bodies that have addressed the ABCP crisis are the Canadian Securities Administrators (CSA), the Office of the Superintendent of Financial Institutions (OSFI), and the Investment Industry Regulatory Organization of Canada (IIROC).
As described in the CSA’s Staff Notice 51-326, Continuous Disclosure Review Program Activities for Fiscal 2008, the CSA had conducted reviews of issuers that held a material amount of nonbank ABCP, focusing on valuation, presentation and disclosure of the non-bank ABCP in financial statements and MD&A. Issuers who did not take into account appropriate factors when determining fair value of non-bank ABCP holdings were asked to restate their financial statements. Many issuers were requested to provide further disclosure in future filings on the methods and assumptions used to determine fair market value and the impact of non-bank ABCP holdings on the issuer’s ability to meet cash needs and planned growth objectives.
ABCP was issued in reliance on the exemption from registration and prospectus requirements in National Instrument 45-106, Section 2.35, Short-Term Debt. This exempts trades in negotiable promissory notes or commercial paper maturing not more than one year from the date of issue, and having an approved credit rating from an approved credit rating organization.
In October 2008, the CSA published a consultation paper outlining several proposals for the treatment of ABCP under Canadian securities regulation going forward. The comment period for this consultation closes on December 20, 2008. Among the topics raised for comment:
- Implementing a regulatory framework applicable to credit rating agencies and a requirement for public disclosure of all information provided by an issuer that is used by a credit rating agency in rating an asset-backed security.
- Amending the short-term debt exemption to make it unavailable for sales of complex asset-backed short-term debt including ABCP, and requiring that these products be offered and sold pursuant to a prospectus or another exemption that might include a new exemption tailored to ABCP and with a disclosure component. The use of the “accredited investor” exemption, including the levels for the current income and net financial thresholds tests, and the $150,000 exemption for the sale of ABCP will also be reviewed.
- Reducing reliance on the use of credit ratings in Canadian securities regulation.
- Addressing, in concert with IIROC, the role played by dealers and advisors with respect to ABCP.
- Reviewing specific issues regarding mutual fund investments, including money market funds, in ABCP.
Earlier this year, OSFI reminded the public that it oversees banks and other financial institutions in Canada and not the firms that created the non-bank ABCP, which are regulated by the provincial securities commissions. On June 19, 2008, OSFI published a draft advisory proposing to modify its guidelines to eliminate the circumstances in which the undrawn portion of a liquidity facility could be excluded from any requirement for capital charges by a bank. OSFI had previously supported a zero capital charge for liquidity lines provided by banks if the support was a “pure liquidity” line, described above as a “general market disruption” line, which could only be drawn if the entire market was subject to a liquidity event. For liquidity lines that could be called upon the occurrence of an event affecting a particular seller of ABCP, also known as a “global style liquidity agreement,” a Canadian bank was required to take a charge against its capital.
For its part, IIROC, the industry self-regulatory organization that oversees investment dealers and trading activity on debt and equity marketplaces in Canada, has published a report on the role played by its dealer members in the manufacture and distribution of third-party ABCP. Its findings include the following:
- Dealer members treated ABCP as a fungible money market instrument offering a slightly higher yield but with little or no higher risk than other money market instruments.
- Dealer members made no distinction between bank-sponsored and third-party ABCP.
- Dealer members and registered representatives gave little consideration to the attributes or risks of third-party ABCP, accepting it in reliance on credit rating and yield.
- Dealer member product introduction processes were generally inadequate as tested by the introduction of ABCP.
IIROC also published a draft guidance note entitled “Best Practices for Product Due Diligence” and invited comments until December 16, 2008.
We will continue to report on ABCP developments in future issues.
For a commentary on the CCAA proceedings, see the corporate restructuring article here.