The Non Bank Asset Backed Commercial Paper Mess
The business pages are covering this rather arcane issue more and more intensively. The Canadian market for so-called non bank asset backed commercial paper or ABCP has more or less frozen up, leaving some $40 Billion in stranded assets. Much of this seems to be held by large pension funds and other large institutions, with the Quebec Caisse exposed in a major way. The ABCP was sold as risk free courtesy of a top credit rating from DBRS, even though the paper not issued by the major Canadian banks had – it turns out – no guaranteed buyer in the event of a crisis, unlike bank guarantees on their own paper. In an independent report, Diane Urquhart (a financial market insider turned public interest advocate) notes that only in Canada were the banks off the hook, being able to not have to buy back paper they sold on in the event of a “general market disruption.” Foreign banks that sold ABCP in Canada are wriggling out of obligations in Canada that they face at home, even though they collected most of the interest rate difference between ABCP and government bonds which represents a risk premium. In short, they charged for a risk they weren’t facing. The Made in Canada liquidity provision is like having fire insurance which does not pay out in the event of a fire. It seems like our major bank regulator OSFI saw no role for themselves as the market for this paper grew exponentially.
So far as I can understand, this paper is worth something. Most of the business receivables that were bundled and sold on are good for most of the paper value. But lack of liquidity means that a lot of assets are frozen, and someone is going to have to take a haircut. The question is how much will be taken by the buyers, and whether the sellers can get themselves completely off the hook. Some suspect that the buyers will get the haircut, and the “saviours” who buy the stuff back at a discount will then sell it on at a big profit.
This is all being sorted out behind closed doors, with governemnt regulators and the Bnk of Canada apparently not participating as the financial industry players and the ABCP holders try to work things out. Maybe somebody is playing a role behind the scenes – one hopes so since the Bank of Canada is struggling to keep the costs of short-term business credit from speading above their target rate.
This seems to be a real Made in Canada financial mess with government regulators asleep at the switch at the outset, and still sitting on the sidelines.
CLC President Georgetti sent this letter to Finance Minister Flaherty last Friday:
Dear Minister Flaherty:
I am writing to urge you to appoint an expert independent monitor to represent the public interest in ongoing discussions to resolve the crisis in the Asset Backed Commercial Paper (ABCP) market.
Some 80% of our 3.2 million members belong to defined benefit pension plans, as do many more union retirees. Many pension plans are at risk of taking a significant hit to their assets because of investments in non-bank ABCPs, according to a major report released yesterday by a respected independent analyst of financial markets, Diane Urquhart. These investments were deemed to be virtually risk-free by pension trustees because of a top credit rating from Dominion Bond Rating Service (DBRS), and the perception that the banks would provide liquidity to prevent a freeze-up in the market (as is the case in most other countries).
The Urquhart report draws attention to the fact that many of the same major financial industry players who marketed non-bank ABCP to pension plans and others are now working out how to resolve lack of liquidity in the market, which is likely to be re-established through a downgrading of asset values. While some large government pension funds are involved in the investor committees trying to work through a solution, there is no person representing the public interest per se.
In this context, we urge you to read the Urquhart report and to give very serious consideration to her proposal to appoint an expert independent monitor.
I am sure you will also be reflecting on what regulatory changes are needed moving forward so that investment products with significant underlying risk are not sold to pension plans as virtually risk-free.â€