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What happened to the ABCP billions?

Two Globe and Mail reporters covering the mayhem surrounding asset-backed commercial paper take questions

Monday, April 07, 2008

It was supposed to be a safe place to park money for 30 to 60 days and do better on the interest than the paltry rates offered by banks.

But non-bank asset-backed commercial paper (ABCP) got sideswiped last August by the subprime mortgage mess in the United States. Suddenly, no one knew how much of the bundled loans and derivates behind the ABCPs was actually repackaged mortgages taken out by U.S. home buyers with questionable credit histories and limited financial resources.

Several institutional investors, including the Caisse de dépôt et placement du Québec – the largest holder of ABCP – moved quickly to come up with a plan to try to prevent mass liquidation of the assets.

The result has been a freeze on the market while a court-supervised restructuring process looks for the most equitable way to sort out the mess. Holders of the non-bank ABCP are scheduled to vote on a solution April 25. But with investors ranging from the country's biggest pension funds, to workers trying to save for retirement, there has been a clash of interests.

On Tuesday at 12 p.m. EDT, the two reporters following the story for The Globe and Mail will hold an online discussion to help readers understand the complexities of the ABCP mess, the unusual process under way to try to fix it and what to expect next.

Boyd Erman, capital markets reporter, is a long-time business journalist who has previously worked at Dow Jones, Bloomberg, and the National Post. Over the years, his areas of coverage have included economics, monetary policy, debt markets and corporate finance. In addition, he is a regular commentator and guest host on Business News Network.

Tara Perkins worked as a business reporter at The Toronto Star and The Canadian Press before joining The Globe and Mail, where she now covers Canada's banks and other financial institutions. She has a Bachelor of Commerce degree in addition to a Bachelor of Journalism degree.

Simon Avery of
Tara and Boyd, thank you for joining us today and stepping up to shed some light on the complex subject of ABCPs. Our first question comes from Pour me another drink of alcohol from Iqualuit who writes:

How much and by whom is Mr. Crawford being compensated to help sort out the ABCP mess?

Tara Perkins:
The cost of the Crawford committee's work will ultimately be paid by investors. In court documents, the committee estimated that costs would come to between $80-million and $100-million for lawyers, financial advisers, the court-appointed monitor and the rating agency. There are 17 members of the committee, including companies, pension plans and crown corporations. They have each been paying their own costs. They have also been paying the financial advisors at JPMorgan, lawyers at Goodmans and others on a pro-rata basis, based on the amount of ABCP they hold. But they hope that the costs will ultimately be recouped once their plan to restructure the market is approved by the court. The costs will then come from assets held in each of the ABCP conduits. That means that, ultimately, they will be paid by investors.

Dennis Shemeluck from Parry Sound, Ontario:
I would like to know when the Canadian bank executives will pay back bonuses? When will the hedge fund boys in America and Canada pay back bonuses? I see that one guy just received over $3-billion in 2007 for selling short/dealing with subprimes! And a few others received over $1-billion. As a C.A., although not in public practice, I see a major issue with poor transparency and bad disclosure rules that are always compromised. I am discouraged after 40 years of being in business. Your comments please.

Boyd Erman:
Dennis, thanks for writing. I don't want to discourage you further, but I doubt that you will see anybody at the Canadian banks or hedge funds pay back their bonuses, though no doubt many bonuses next year will be a lot smaller for those who were involved directly in ABCP (and that's just the ones that still have jobs.) It seems odd that anyone would profit from the misfortunes of others, but markets are in many respects a zero sum game. For every loser, there must be a winner, because someone always has to take the other side of the bet.

However,your questions about transparency and disclosure raise very serious issues that I expect that regulators will continue to address as we work our way out of this debacle. They will look at disclosure at the level of mortgages given to individual homeowners, as well as at disclosure of the risks inherent in the assets such as ABCP that were backed by those mortgages. Already, even before regulators have had their say, investors are pushing for more disclosure and that should be a positive outcome from this mess.

C.M. from London, Ontario:
We keep on hearing the term 'liquidity crunch'. What exactly does that mean? Why is making billions of dollars of government money available to banks as short term loans the solution to the problem?

Tara Perkins:The liquidity crunch essentially means that there isn't enough available money sloshing around in the global system. When the U.S. subprime mortgage market caused the markets to panic in August, investors balked at any investment that might have any tie whatsoever to subprime. They pulled their money back from a whole host of global investment products, including Canadian third-party asset-backed commercial paper. The ABCP market suffers from a lack of liquidity because investors do not want to own it right now - there is no active market. Central banks have been making it easier for commercial banks to borrow money in order to inject added liquidity into the system. The period since August comes on the heels of a time when there was a lot of liquidity in the system, which might have spurred some investors to take on more risk than they normally would.

DChing from Toronto: If the vote is no, what is the likelihood that the Committee will reconvene and put another plan on the table? Is it more likely they will just walk away and proceed with an event of default? If there is a fire sale, what type of compression do you expect to see on value? More specifically, if I own a series that has a particularly high valuation, can I expect to see some decent money back in liquidation?

Boyd Erman: The committee hasn't said whether it would try for another solution if this one failed, but my gut tells me that this is a one-shot deal. Given the trouble the committee had getting all the parties to agree to this proposal, blowing it up and starting again seems unlikely. Even if the committee members were willing to try, getting the asset providers who are on the other side of many of the swaps trades to agree to stand still for another few months seems like a very long shot. That means that an event of default is the most likely scenario, and then the "fire sale" that everyone has been talking about. At that point, what a holder can expect depends largely on the mix of ABCP in any given portfolio. But the average result is likely to be very poor. As of March 4, almost every derivative trade backing the ABCP was facing a margin call, meaning that the bank on the other side of the trade would be in a position to seize collateral from the ABCP trusts.

The best way to think about this is it's like a bank foreclosing on your house. No matter what the house is worth, you're not likely to see any money when the bank takes and sells it to cover debts. For investors whose ABCP is backed by more traditional assets such as car loans, recoveries might be a little better. But keep in mind that traditional assets represent only about one-quarter of all the assets in the $32-billion restructuring.

Paul DiSalvo from Canada: I'm awaiting a beneficial solution and hope this occurs. However, I want to be prepared to turn down the restructuring as presently proposed since it has too many unknowns. What is the process to register a negative vote? What documents need to be signed and who do I send these to? Thanks for your help.

Tara Perkins: Investors must first submit a voter identification form or voter confirmation form to Ernst & Young, which is helping to run the voting process on behalf of the court. That must be done by 5:00 p.m. Toronto time on April 22, and it needs to be accompanied by a statement from your broker or bank. You can then mail in your vote on a green proxy form, which must be received by 5:00 p.m. the last business day before the April 25 vote. You can change your mind up until then as well. For full details, start by going to and contacting Ernst & Young.

Sebastian Aleksander of Toronto: Ernst & Young's web site for the ABCP holders contains a 'FORM OF ELECTION'. It allows holders of ABCP to choose whether to participate in something called MAV1 or MAV2. What is the difference between MAV1 and MAV2? Are there any advantages for retail holders of ABCP to select one or the other?

Boyd Erman: Sebastian, MAV1 and MAV2 are "Master Asset Vehicles." The idea is to pool all of the different assets backing the whole $32-billion of frozen asset-backed commercial paper and then give out new notes. What the committee has done is to propose three different pools that will each issue new notes. MAV1 and MAV2 are pools that will have all of the "derivative" or "synthetic assets." MAV3 will have traditional assets such as car loans and credit card loans.

So what's the difference between notes issued by MAV1 and MAV2 if they both are backed by "synthetic assets?" I'll do my best to help simplify, but bear with me, because like most things ABCP-related, it's not all that simple. MAV1 will be for investors who can tolerate more risk. The notes issued by MAV1 won't have any backup line of credit to help ensure that MAV1 notes can continue to pay interest in case of another upheaval in markets. In return for taking that risk, investors in MAV1 will get a higher interest rate. MAV2 notes should theoretically be safer, because there is a backup line of credit from big banks in Canada and around the world that will help MAV2 stay solvent in another market meltdown. But that line of credit comes with a cost, so the interest rate will be lower on MAV2 notes. Despite the lower interest payments, MAV2 will be the only realistic option for many smaller investors. To participate in MAV1, an investor must be an institution with at least an AA credit rating or have approval from the committee, and be able to set aside money as collateral in case of a market meltdown.

Vic Hotte from Canada: I have heard that TD Bank wouldn't touch ABCP investments, but don't know if the bank could have avoided those papers entirely if they were included in mixed financial instrument. Is it true that Standard & Poor's and Moody's would not rate ABCPs because they couldn't understand their investment structure, while Dominion Bond Rating gave them an AAA rating? Is it true ABCP instruments were listed on the TSX without a prospectus, the same way Bre-X was listed? If these 'rumours' are correct, there were plenty of reasons for financial institutions and stock markets NOT to get involved with this sizeable scam, and only one flimsy reason to do it: percentage bonuses based on how much ABCP paper was sold. How do we get politicians and bankers to understand the benefits of sustainability, instead of booms, bubbles and busts?

Tara Perkins: Hi Vic. It is true that credit-rating agencies Standard & Poor's and Moody's did not rate the paper in Canada's third-party ABCP market, largely because of what I will call a "loophole" in the Canadian paper. That loophole was a clause in many of the emergency funding lines that were supposed to protect the ABCP in tough times. The clause stated that the emergency funds, which were to come from many foreign and some Canadian banks, only had to be paid in the event of a "market disruption." When the market collapsed in August, and the ABCP sector turned to the banks for emergency funding, some of the banks balked, saying that the entire market had not been disrupted (they based that assertion on the fact that commercial paper in the much larger bank-sponsored market in Canada continued to function relatively smoothly). DBRS was the only rating agency that agreed to rate paper with the market disruption clause. It is also the only rating agency, so far, that has agreed to rate the new notes that would come from the restructuring of this market under the Purdy Crawford committee's plan.

It is true that ABCP was sold under a prospectus exemption, but this is very different from the Bre-X situation, for instance, ABCP was not a stock listed on a market such as the Toronto Stock Exchange. TD Bank chief executive Ed Clark explained last week that, as CEO, he did not want his bank to become involved in any area of the market that he does not personally understand. In other words, TD stayed away from many complex investment products.

Byron Turner from Little Current : Which Pension funds are admitting to be the most at risk here?

Boyd Erman: One only needs to look at the list of the major players on the Pan-Canadian Investors Committee to see who has the most at stake in this restructuring. The biggest player is the Caisse de depot et placement du Quebec, which has about $13-billion of affected paper that would be vastly reduced in value should the restructuring fail. After the Caisse, big holders include PSP Investments, which invests money for many federal government employee pensioners, and Canada Post's pension fund. University of Western Ontario's pension plan also has some. Pension plans aren't the only ones with big holdings. The Ontario and Yukon governments have frozen ABCP, as does Nav Canada, which runs the country's air-traffic-control system, as do many corporations.

Theo Lichacz from Pontypool Canada: Considering the housing meltdown in the U.S. The bankers who engineered that catastrophe are supposed to be captains of the economic ship. How did it reach the point it has? Some ship. Some captains. Do we enable them the powers to fix the mess they created and then pass evermore complex/stringent guidelines and oversight procedures? Or should we be calling them criminals? Better still should we be calling them inmates, along those who enable their greed?

Tara Perkins: Hi Theo. You are correct in suggesting that the current crisis spun out of control after many of the smartest minds in banking failed to spot it coming. From chief executives of major banks, to credit rating analysts and regulators, you would be hard-pressed to find someone who would say they haven't been caught off guard in recent months by the breadth and depth of the financial crisis. And it is true that the banking and financial industry at large inadvertently enabled this situation, for instance by spreading their risks around to investors around the world through the use of complicated structured products. The mortgage sector in particular is shouldering a fair share of the blame. And many banking executives have lost their job in recent months. However, I do not think this is a criminal situation. And, one could argue that many investors have to take a share of the blame as well, for investing in products that they did not fully understand or that carried more risk than they could handle. While it seems clear that some new regulations will result from the crisis of recent months, many in the financial industry are hoping that they do not go so far that they do more harm than good to the banking sector, which is clearly struggling at the moment.

Greg Bewsh from Toronto: Should the vote be no, the administrator BlackRock will go away and Coventree is winding up. Who will administer these assets?

Boyd Erman: Greg, that's unclear, as frankly nobody really wants to talk about the realities of what would happen post-"no" vote. In many respects, the only certainty would be chaos. There's a good chance that because most of the trusts would end up insolvent just days after a no vote, thanks to asset seizures by creditors, any remaining assets would go into limbo until a court could appoint a bankruptcy monitor.

Simon Avery: And I am afraid we will have to close out on that note for today. Thank you Tara and Boyd, and thanks to our readers for the questions.

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