BoC offers no reprieve for frozen paper

While the Bank of Canada has been vocal in its support of the restructuring process for Canadian asset-backed commercial paper (ABCP), it made clear on Monday that it’s not going to bail anyone out, as the U.S. Federal Reserve has with American investment banks.

The Bank announced the eligibility criteria and conditions to accept ABCP as collateral for the Bank of Canada’s Standing Liquidity Facility (SLF). For the most part, the conditions are quite restrictive and make it virtually impossible to use any of the more than $30 billion in frozen ABCP that is currently subject to a restructuring proposal by the Pan-Canadian Investors Committee for Third Party Structured ABCP.

“Third party, or non-bank, sponsored ABCP does not meet the criteria as set out by the Bank,” a BoC spokesperson said in a statement to Advisor.ca. “It remains the Bank’s view that the agreement by major investors and liquidity providers to pursue an orderly restructuring of the Canadian market for non-bank sponsored asset-backed commercial paper (third party ABCP) is providing an opportunity for parties to work through the many complex issues related to the market for asset-backed commercial paper.”

The BoC proposed the requirements on March 5, and then engaged in a consultation process with 11 market participants. The requirements will apply to all ABCP effective immediately. The bank told Advisor.ca the eligibility requirements are instead a way to increase the transparency of ABCP in general.

“It’s important to go back to the policy objectives that guided the Bank’s decision to accept ABCP as collateral for the SLF, namely the second objective that the eligibility criteria should facilitate the development of a well-functioning market for ABCP by promoting more transparency for investors and by encouraging an active secondary market for these securities,” the statement said.

In other words, the eligibility requirements are more or less guidelines for future ABCP issuances.

Among the conditions of eligibility will be the requirement that each sponsored ABCP has received at least an A rating or the second-highest rating from a minimum of two rating agencies. At present, the frozen ABCP has only been rated by Dominion Bond Rating Services. While initially much of it was highly rated, a good portion of it was downgraded to D when it was placed under creditor protection.

The BoC also stated the program must not contain any actual or potential exposure to assets that were securitized prior to being acquired by the conduit, with the exception of National Housing Act mortgage-backed securities. This virtually eliminates any ABCP that has any structured investment component to it — which participants who commented on the requirements noted implies a “significant portion” of outstanding ABCP.

“The Bank recognizes that the restriction on securitized assets would limit the subset of ABCP eligible as collateral,” the BoC wrote in its reasoning for this rule. “However, the lack of standardization in reporting as to the nature of securitized assets and degree of securitization in ABCP programs does not presently meet the transparency objectives of the Bank. In the event that the market for ABCP evolves to include more standardization and clarity in reporting, the Bank would reconsider this criterion.”

Other eligibility requirements demand that the ABCP not utilize leverage to acquire assets; only senior tranches will be accepted, and no more than 20% of the value of the collateral pledged by one institution can be ABCP-sponsored by a single institution.

The BoC’s collateral requirements stand in stark contrast to the steps taken by the Fed earlier in March, when it created a lending facility for primary dealers that allowed access to liquidity for up to six months using “a broad range” of investment-grade securities as collateral.

This has been interpreted as a market-wide bail-out that allowed primary investment dealers to use illiquid investment-grade mortgage-backed securities to secure a line of credit. Market observers have suggested investment dealers can now transfer the risk associated with structured investment vehicles to the Fed.

Some market participants who commented on the BoC requirements asked the Bank to create a list of ABCP trusts it would consider eligible, which could help with liquidity problems if investors knew certain ABCP had the Bank’s seal of approval. The BoC rejected this request.

“The issue was raised as to whether to publish a list of ABCP programs that met the Bank’s criteria. Some indicated that this would be useful, while another respondent expressed concern regarding the potential for investors to rely on the Bank of Canada’s assessment rather than performing their own due diligence. The Bank does not plan to publish a list of ABCP programs that are eligible as SLF collateral,” the BoC wrote.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com