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Regulator says brokers failed on ABCP, sets new guidelines


October 17, 2008 at 7:21 PM EDT

Canadian brokerage firms did little to review asset-backed commercial paper products before selling them to retail investors, according to a report by Canada's brokerage industry regulator.

The Investment Industry Regulatory Organization of Canada (IIROC) reported yesterday on a year-long compliance sweep of firms involved in selling non-bank ABCP to Canadian investors, laying out new guidelines to change the way investment firms review products before selling them to clients.

"There was very little understanding, generally speaking, of what this product really was all about," IIROC chief executive officer Susan Wolburgh Jenah said yesterday. She said brokerage firms reported they saw non-bank ABCP as little different from traditional commercial paper, even though IIROC concluded there were major risk differences.

The review concluded 76 per cent of the assets underlying non-bank ABCP were complex financial derivatives like synthetic collateralized debt obligations, whereas bank-sponsored ABCP had only three per cent of those types of derivatives and had 97 per cent traditional commercial paper assets like credit-card receivables. "The name asset-backed commercial paper was a misnomer. They were liability-backed," Ms. Wolburgh Jenah said.


The non-bank ABCP market collapsed in August, 2007, leaving investors holding about $35-billion of frozen notes, including 2,542 individuals with investments totalling $317-million. Many individuals were seniors or other risk-averse investors who reported they were assured ABCP was as safe as a bank GIC or other guaranteed product.
The report said none of the 21 Canadian brokerage firms that sold third-party ABCP to clients had reviewed the product through their internal due diligence process. Under such a process, committees assess whether new products are suitable for a firm to sell to corporate or retail clients.

IIROC said most firms reported they did not do due diligence reviews because they relied on the high credit rating the ABCP notes received from DBRS. Industry participants also reported they felt ABCP was a typical money market instrument that did not require risk assessment.

Bank-owned brokerage firms relied on reviews by their parent banks, the report added, but most of the reviews were done to establish credit and trading limits as part of financial risk control. Only one unidentified bank reviewed the product from a client suitability perspective and decided not to sell it. Toronto-Dominion Bank has previously disclosed it did not sell ABCP to clients.

IIROC said member firms that did not sell ABCP to clients reported they did not believe their clients would understand the product, or that there were simpler alternative products, or that there was little profit on the transactions. Indeed, the report said all dealer members who sold ABCP to retail investors reported the product was viewed as a "loss-leader" service to clients and not a profitable product.

No firms or brokers have been sanctioned by IIROC for selling ABCP to clients for whom it was not a suitable investment under the industry's know-your-client rules. Ms. Wolburgh Jenah said IIROC has not completed its reviews of complaints from clients.

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