While the broader and more politically-charged aspects of the regulatory response to the debt crisis of 2008-09 remain largely unresolved, securities regulators have already begun the process of mapping out the implications of this crisis for the ABS market. The generalities of the recent recommendations of the International Organization of Securities Commissions (IOSCO) have already given way to the specific and detailed agenda set forth by the SEC in its reform proposals approved for public comment on April 7, 2010. While the main tenets of the reforms – greatly increased transparency, CEO accountability and risk participation by program sponsors – are interesting and merit discussion and debate, the proposed mechanism for mandating reform is intriguing in and of itself, and particularly so in the Canadian market context.
As is the case with all aspects of securities regulation, the proposed reforms of the ABS market do not aspire to relieve all ABS investors of the burden of caveat emptor. The new expectations to be imposed upon issuers and sponsors of ABS are proposed only as conditions upon those who wish to avail themselves of the procedural and market capacity benefits available in the context of short form public issuance. In essence, the new rules say that if you wish to access the debt market in an expedited fashion to be able to capitalize upon windows of opportunity for public issuance, your investors must be given adequate minimum levels of disclosure to assess the risk of the proposed investment, must have some assurance that the CEO of the entity that originated the underlying assets believes that the investor will be paid out by the assets in due course and must be assured that the program sponsor is exposed to a material risk of loss that ranks at least equal to that assumed by the public investor. These new requirements, among others, are entirely restricted to public issues. To the extent that an ABS issuer can find sufficient investor capacity without utilizing the prompt offering system to issue debt securities, the proposals require little more than evidence that private market investors have been expressly offered prospectus level disclosure.
There are obvious merits to these proposals, and there are also costs and complexities for the issuance process raised by them. However, apart from the analysis of the balance between these benefits and costs, it is interesting to consider the effectiveness of the carrot offered to ABS issuers by these proposals. Implicit in the SEC’s regulatory thinking is the assumption that short form offering capability for ABS issues is such an essential component of cost-effective capital market access that this condition of utilization will be a sufficient lever to effect major reform of the ABS market.
In the context of the pre-crisis ABS market, such an assumption appears entirely reasonable. The issuance data reported in the database maintained by trade publication Asset-Backed Alert shows that in the calendar years 2005-2007, issuance of public ABS (excluding MBS and CMBS) in the US was consistently far in excess of private placement (Rule 144A) offering volumes, being over eight times more in 2005, over four times more in 2006 and still just under three times more in 2007. With the advent of the depths of the debt crisis in 2008, public and private ABS issuance reached virtual parity, and 2009 saw 144A issuance outstrip public issuance by 15%. More striking still, for the first quarter of 2010, Asset-Backed Alert has reported over US$21 billion of 144A ABS issuance versus only US$9 billion of US public ABS.
The story in Canada is no different in Canada. DBRS has reported that rated ABS private placements now constitute 4.0% of all outstanding ABS by dollar volume, a remarkable statistic given that rated private placements had not been offered in the Canadian ABS market before 2007. The recent rise of private placements in the Canadian market is even more striking when one considers that the portion of the current Canadian ABS outstandings categorized as public ABS includes C$3.7 billion purchased by the Business Development Bank of Canada as the administering agency for the Canadian Secured Credit Facility, the government program created to assist in rekindling demand for automobile and equipment receivable-backed ABS. CSCF issues were public in form only, utilizing the short form offering system only to meet the requirement for CSCF participation but were otherwise distributed very narrowly, and were in most cases purchased by BDC alone. Outside of this notional CSCF public issuance, the Canadian ABS market has only seen five public issues since 2007, including one retail and one wholesale automobile receivable-backed deal brought by Ford Canada, a retail automobile receivable-backed deal brought by GMAC and recent credit card-backed issues from each of Royal Bank of Canada and CIBC.
The reasons for this change in the balance between public and private market issuance could reflect growing market unease over looming regulatory changes to the rules governing public issuance. The dramatic change in US issuance patterns in the first quarter of 2010, during which the general disclosure recommendations proposed in the IOSCO report would have been available to the market, would seem to support such a conclusion. However, it is also apparent that average transaction size for US private placements increased only marginally from its historic level of roughly US$500 million, so it could also be that the shift away from public issuance merely reflects the economic realities of bringing smaller transactions to market.
In the Canadian market context, the rise of the private placement market may also be a manifestation of an underlying aspect that reflects a more profound refocusing of distribution efforts. Anecdotal reports would suggest that material portions of at least the shorter-dated tranches of some of these private issuances (and companion tranches issued in connection with CSCF issues) have found their way into the hands of US investors. This new source of liquidity for Canadian ABS has arisen almost simultaneously with the January 1, 2008 elimination of the federal withholding tax on interest paid to US-resident investors by Canadian-resident debt issuers, lending significant credibility to those that have long advocated that such a change in Canadian tax policy would be a transformative development for the Canadian ABS market.
Given the emerging trends in the evolution of the ABS market in both Canada and the US, a starting point for the debate about the efficacy of the SEC proposals for the reform of the ABS market might well lie not with the merits of the substance of the proposals but rather with the question of the effectiveness of short term public issuance eligibility as the means of introducing any reforms to that market. In the Canadian context, an even more specific market transformation might need to be addressed, given that it appears that it might be the depth of the US market for the private placement of Canadian-originated asset-backed offerings rather than access to short form issuance of public ABS that will dictate the immediate prospects for market growth. In either case, securities regulators might need to face the more problematic task of imposing reforms upon private market players in an effort to address the substantive market deficiencies that have been identified in the context of the most recent market crisis.