THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 240

208

PA R T I I I

FYI

Financial Institutions

Canada s Asset-Backed Commercial Paper Saga

As we noted in Chapter 2, commercial paper
is short-term, unsecured debt issued by corporations, typically for financing accounts
receivable and inventories. Asset-backed
commercial paper, like traditional commercial
paper, is also a short-term security (with a
maturity that is typically less than nine
months). It is issued by conduits (that is,
bankruptcy-remote Special Purpose Vehicles),
but instead of being an unsecured promissory
note, is backed by physical assets such as
mortgages, trade receivables, credit card
receivables, automobile loans and leases,
and other types of assets. Because of this
backing, the quality of the ABCP depends on
the underlying securities and thus ABCP
could be very risky. For example, if there are
negative developments in the underlying
markets, the risk of ABCP will increase and
investors will switch out of ABCP and into
safer money market instruments such as traditional commercial paper, bankers acceptances, and Treasury bills. As a result,
conduits will not be able to roll over their

ABCP and will face a liquidity crunch.
The ABCP market in Canada expanded
very rapidly from the 1990s to 2007. As at
July 31, 2007, the size of the Canadian ABCP
market was $115 billion (equal to about
32.5% of the Canadian money market), of
which $80 billion was bank-sponsored and
$35 billion was non-bank-sponsored. At the
same time, the ABCP market in the United
States was approximately US$1.2 trillion,
equal to about 50% of the U.S. commercial
paper market. Bank-sponsored ABCP conduits are invested in plain vanilla assets
such as residential mortgages and credit card
receivables. Non-bank-sponsored ABCP conduits are invested in structured finance assets
such as collateralized debt obligations (CDOs)
and subprime mortgages. Canadian banks are
involved in the distribution of ABCP and also
provide liquidity back-stop facilities to nonbank-sponsored ABCP conduits under the
so-called general market disruption clause.

In August of 2007, investors in the
Canadian ABCP market declined to roll over
maturing notes because of concerns about
exposure to the U.S. subprime mortgage sector in the underlying assets. As a result, the
market was divided into those ABCP conduits that could honour their obligations
(bank-sponsored) and those that could not
honour
their
obligations
(non-banksponsored). In the case of bank-sponsored

ABCP, the Big Six banks took back onto their
balance sheets significant amounts of their
own sponsored ABCP. Moreover, valuation
and fair-value issues led to significant write
downs in the fourth quarter of 2007 and the
first quarter of 2008. In the case of non-banksponsored ABCP, a number of conduits faced
significant liquidity shortages, seeking liquidity funding support from their liquidity
providers (banks). However, major liquidity
providers denied requests for liquidity
support, arguing that the general market disruption clause was not met. They interpreted the clause to mean that the majority of
the conduits in the entire Canadian ABCP
market would need to be unable to roll over
before a liquidity provider had to step in. As
a result, the Canadian non-bank-sponsored
ABCP market froze and investors, including
Quebec s huge pension fund, Caisse de d p t
et placement du Qu bec, Alberta s ATB
Financial, the National Bank of Canada, and
about 2000 individual small investors, had
their cash frozen in non-bank-sponsored
ABCP.
At the time, the Bank of Canada indicated
that it would not accept ABCP as collateral
for loans to banks and that a solution from
participants in the ABCP market was deemed
to be appropriate. As a result, major market
participants, including non-bank-sponsored
ABCP conduits, institutional investors, liquidity providers (ABN AMRO Group, HSBC,
Deutsche Bank, Merrill Lynch, Barclays
Capital), and the Affected Trusts, reached an

agreement on August 16, 2007, known as the