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.”


  • “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)”

    In the markets, buyers must be responsible for what they purchase. If they aren’t aware of the various risks they are adopting when they buy assets like ABCP, they open themselves to all potential consequences. The DBRS should not be blamed here, nor a lack of regulation. Investors such as the above pension trustees should be blaming themselves.

    It is true that Canadian ABCP did not have the same guarantees that ABCP issued in other countries did. But this bit of knowledge was not something that suddenly appeared in August. It was a public fact of Canadian commercial papers and had been so for some time.

    I quote the Bank of Canada from a 2001 press release: “The Bank has identified some legal, operational and structural risks associated with assetbacked
    securities (ABS), other than those guaranteed by CMHC, which are not present in the case of conventional debt securities. The Bank is in the process of examining these risks and possible means of addressing them. Until they are satisfactorily addressed, ABS (other than those guaranteed by CMHC) will not be eligible as collateral under the SLF.”

    Even the Bank of Canada knew as early as 2001 that ABS were risky assets. If the BoC knew, there’s no way that the pension funds didn’t. The point here is not that ABCP should have been regulated, but that the the lack of sufficient guarantee on Canadian ABCP were common knowledge years ago.

    Caveat emptor, folks. Read the fine print.

  • With regard to ABCP the writer above states “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.”

    His statement applies equally to many other fiascos that have impoverished small investors.

    Now the ABCP fiasco will inflict pain on large investors as a result of Canada’s fractured regulatory system being either unable or unwilling to provide protection for investors.

    Whether Canada opts for a national regulator or continues with the current system, investors will be at risk until Government establishes an authority that has the power to punish perpetrators and provide restitution to victims.

    It is no coincidence that Conrad Black is facing the possibility of incarceration in the United States while John Felderhof, former chief geologist and vice chairman of Bre-X, labelled scam of the century, has been let off by the Canadian regulators and gets to keep all of the loot he obtained from this massive fraud.

    It is time investors large and small unite to force Giovernment to take action to deal with this apalling situation.

    Stan Buell
    Small Investor Protection Association

  • I think the key issue at hand is where do we go from here? A few key investors that hold a supermajority have appointed Purdy Crawford to lead the Montreal Accord, now known as the Pan Canadian Committee to find a solution to the problem. Their proposal is to restructure the ABCP to match the maturity of the assets, which means that investors may wait up to ten years to receive their money back. It was recently announced that the restructure will complete by the end of March 2008. The committee has also chosen to withhold information in the Data Room to prevent secondary trading.

    It appears that progress is being made and I applaud the efforts of Committee on this difficult restructure. Having said that, we still seem to be missing the principles of something our nation is very proud of – capitalism and an open economy. Whether an investor holds $1 or $1 billion of ABCP, it seems counterintuitive to say that they are not allowed to sell their assets. What the Pan Canadian Committee is missing is a second option for investors to sell their assets immediately in the event, they cannot wait until March 2008. In order for this to happen, the Committee must release the information in the Data Room to the public to allow meaningful secondary bids. As the assets continue to be of strong credit quality, there is certainly demand from various hedge funds and fixed income portfolio managers to buy the assets. However, they cannot do this without information. By providing data, secondary investors will have the tools to conduct prudent analysis for their investment decisions and offer bids higher than 50 or 60 cents. With multiple bids, this will enhance the pricing on these investments and at the end of the day, investors who cannot wait any longer have a choice to sell their assets or not.

    As an individual who has invested over six years in this industry, I feel a personal responsibility to see a fair resolution for all investors. Fair to me means the ability to make a choice between working with Committee or selling the assets in a secondary market. Let’s level the playing field for all investors let’s back to the fundamentals of an open market that we are all proud of in Canada.

    Daryl Ching
    Clarity Financial Strategy

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