Investors Scrutinizing the Regulators

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ABCP turns out to be our version of toxic paper


Friday, December 05, 2008

When the market froze up last year for third-party asset-backed commercial paper in Canada, it was an early canary in the coal mine.

It turned out to be a harbinger of a much bigger credit crisis to come.

More than a year later, the $35-billion ABCP market is still in deep freeze, despite the so-called Montreal Protocol that sought to revive it.

The accord aimed to convert the short-term paper (backed by mortgages, car loans, credit card receivables and the like) into longer term notes that could trade in a secondary market. But the deal has been held up by lengthy legal wrangling.

Investor frustration is running high and the damage is substantial.

The delay has been blamed, in part, for liquidity pressure at Quebec's pension fund manager, the Caisse de dépôt et placement, which had a $13-billion portfolio of ABCP on its books.

Many corporations that put their cash into ABCP have yet to be made whole by dealers that sold them the paper.

Now, we're finally seeing some attempts at investigating how this scandal occurred.

The chairman of the Ontario Securities Commission, David Wilson, said this week that regulators in Ontario and Quebec are looking into what happened and whether enforcement charges will be laid.

Jean St. Gelais, head of Quebec's Autorité des marchés financiers, said in a September speech that the regulatory agency was investigating the sale and distribution of ABCP in Quebec and would examine whether administrative or legal sanctions should be taken.

A spokesperson at the Autorité said yesterday that the agency is still gathering information on what happened and has not begun any formal investigations.

"We're not there yet," said spokesman Sylvain Théberge when asked if charges could be laid, "but it's not excluded."

At the very least, a crackdown on marketing and sales practices is in order in the financial industry - one that puts full disclosure at the top of the agenda.

And if companies and executives broke the rules in the way they sold the dubious ABCP notes to unsuspecting investors, then they should suffer the legal consequences

Canada may not have had a subprime mortgage scandal, but ABCP has turned out to be our own version of toxic paper.

"The liquidity crisis was fuelled largely by a lack of transparency in the ABCP scheme," noted an August judgment from the Ontario Court of Appeal. "Investors could not tell what assets were backing their notes."

The notes shared "an Achilles heel," the court found. "Because of their long-term nature, there was an inherent timing mismatch between the cash they generated and the cash needed to repay maturing ABCP notes."

In October, the investment industry's self-regulatory body weighed in with a report on what happened.

The 113-page report by the Investment Industry Regulatory Organization of Canada found there was insufficient disclosure, and a lack of due diligence in the way ABCP was sold.

The real question is whether there was widespread infringement of the know-your-client rule that's sacred to the trust between a client and a financial adviser.

In April, when investors attended a meeting of the ABCP restructuring committee headed by lawyer Purdy Crawford, they gave the committee an earful.

Many had been led to believe their investment was safe. Some were elderly people who had their life savings at risk. They thought they were buying a savings product, when in fact they were buying a risky investment.

Much of this had to do with the solid-gold credit ratings wrongly affixed to ABCP by bond-rating agencies that have forfeited their trust.

Since then, dealers have implemented or committed to compensation plans for clients amounting to almost $500 million. Some have made special lending arrangements to support corporate clients in ABCP.

But the full legal price hasn't yet been paid by greedy financial industry people who either did not do their homework or knowingly sold unsuitable investments to their clients.

There's been a lot of talk about the need for more regulation in the wake of the global financial crisis.

A good start would be to hold people in the financial industry accountable for their actions.

© The Gazette (Montreal) 2008
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