Canadian asset-backed commercial paper (ABCP) — a segment of the money markets that fell out of favour during the global financial crisis — may re-emerge, says Fitch Ratings.
In a report, the rating agency said the discontinuation of the Canadian Dollar Offered Rate (CDOR) benchmark means the market for Banker’s Acceptances (BAs), which are priced off of CDOR, is expected to disappear too.
The BA market represents about 20% of the Canadian money markets, Fitch said.
“The market does not anticipate that any single instrument will wholly replace BAs,” the report said. “Sponsored by major Canadian banks and backed by diversified traditional underlying assets, the ABCP market is positioned to potentially expand and partially fill the anticipated $90-billion gap stemming from the cessation of BAs issuance.”
This would mark a comeback for Canada’s ABCP market, which took a serious hit during the global financial crisis, when part of the market seized and had to be bailed out by an ad hoc group of financial market players.
The episode also led to regulatory action against some of the investment dealers that had sold ABCP to their clients as low-risk vehicles without fully understanding the products.
As a result, approximately $60 million was paid out to harmed investors as part of enforcement actions brought by the Ontario Securities Commission and Investment Industry Regulatory Organization of Canada against a number of dealers.
Fitch noted the turmoil in the Canadian ABCP market during the financial crisis was confined to instruments that weren’t sponsored by banks and had begun to hold a large portion of their underlying assets in increasingly exotic financial instruments, such as collateralized debt obligations (CDOs), which left them exposed to the collapsing U.S. subprime mortgage market.
“The lack of transparency about the underlying assets further exacerbated the situation, leaving most investors uncertain about the specifics and value of the assets backing their CP notes,” Fitch said. “As a result, approximately $32 billion worth of non-bank sponsored ABCP could not be rolled over.”
The segment of the market that seized was ultimately rescued in an industry bailout that also led to the disappearance of non-bank ABCP. “Since then, the non-bank sponsored ABCP segment has never recovered and has ceased to exist as of today,” Fitch noted.
These days, bank-sponsored ABCP, which performed well during the financial crisis, dominates the current Canadian ABCP market, it said.
“These consist of 20 traditional multi-seller conduits backed solely by traditional assets,” it said, adding that these instruments have no exposure to the kind of synthetic assets that underpinned the market’s trouble back in 2007–2008.
And since the financial crisis, “new regulations have been implemented to improve the transparency of ABCP in Canada,” Fitch said. Securities regulators have not only prohibited the inclusion of risky synthetic assets, they also set liquidity conditions and have increased disclosure requirements for ABCP issuers.