Canada’s asset-backed commercial paper (ABCP) market has been poorly regulated and many investors do not understand the nature of the assets, but these issues are likely to change because of the recent liquidity crisis, according to experts.
Speaking at the Association of Financial Professionals of Canada forum in Toronto last week, Dr. Lloyd Atkinson, the former executive vice-president and chief economist at Bank of Montreal, said the days of lax oversight and complicated asset classes in Canada are over. “You’ll hear lots about the so-called R word, in this instance being the regulators. And trust me on this one, the regulators are going to be coming, and we’d better get used to it.”
In his view, the key element regarding increased scrutiny of asset-backed markets is getting the regulators to focus on the right issues, namely leverage. “In a world particularly where you’re marking to market, it does not take much of a change in the value of those assets to kick an awful lot of companies completely offside when they are highly leveraged,” Atkinson said.
Citing the case of Bear Stearns, which had a leverage ratio of 35:1 when it ran into trouble, he said that the industry shouldn’t be surprised to see new restrictions on all financial institutions. Atkinson added that along with leverage, regulators should also deal with the issue of disclosure, explaining that there are many segments of the financial sector in which disclosure is almost absent. “I understand the reluctance of hedge funds to disclose their strategic positioning in the market,” he said. “But my guess is that at a bare minimum, on a regulatory front, we’re going to see regulators deal with leverage and disclosure.”
Ken Thompson, managing director of Citigroup, agreed with Atkinson, illustrating the disastrous combination of poorly regulated markets and what he referred to as the “twin storms” of subprime mortgages and levered loans which were packaged, securitized, and given AAA ratings to be traded on the securities markets. “Investors were taking subprime assets and funding short-term for long-term assets; never a great strategy from an asset liability management perspective,” he said. “It’s particularly challenging when you have assets at the front end you can’t roll over, and that’s what ended up happening.”
Despite the recent turmoil, Thompson said the overall ABCP market is still sound. “ABCP has tapered down from $1.2 trillion to about $800 billion, but nonetheless still makes up a very significant portion of our market,” he said. “We would expect that type of level to continue going forward.”
Jerry Marriott, managing director at DBRS said the main issues are now being dealt with and are not expected to arise again in the foreseeable future. The so-called Montreal Accord (negotiated by a restructuring committee led by Toronto lawyer Purdy Crawford) has been approved, and although appeals from certain investors are expected, the way forward is clear, he said. Although the investor base has contracted from a high of $120 billion, Marriott expects it to stabilize at $60 billion to $70 billion, and explained that regulation of the market has already begun. “To Lloyd’s comment that the regulators are coming, they’re already here,” he said, adding that regulators recognize the need to be more active in the asset-backed market.
Atkinson said that although there is a substantial appetite for commercial paper in Canada, investors are uncomfortable with ABCP when they don’t understand the assets behind it, so clarity is needed in the market going forward. “We have seen single-issue asset-backed paper,” he said. “We’ve seen it on credit card receivables where they are very clearly identified. There’s a huge appetite for it.”
Marriott added that he expects the ABCP market to become less complex, focusing on traditional assets such as credit cards receivables, auto loans, and mortgages. For more about the ongoing ABCP story, click here to visit our special section, The Paper Chase.
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