Investors Scrutinizing the Regulators

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Flaherty shouldn't wear ABCP mess

Jim Middlemiss

Wednesday, December 17, 2008

Lawyers restructuring the $32-billion assset-backed commercial paper market will be back in court tomorrow seeking to extend the court-ordered stay to Jan. 16, 2009.

The current stay expires on Dec. 19, and the Pan-Canadian Investors Committee overseeing the restructuring wants a $9.5-billion back-stop facility needed to turn short-term notes into long-term paper. It has an agreement in principle on a moratorium for collateral calls and its moved the spread-loss triggers.

A spokesman says "the committee is working diligently to identify and put in place the $9.5-billion in backstop financing before the current court-imposed standstill expires. The outcome on Friday is unknown, but we are confident an appropriate solution will be found."

The committee is mum on where it will get the latest backstop, but all fingers point to taxpayers and the kindness of Jim Flaherty, the federal Finance Minister, who has his own problems writing a budget that will save his government from exile in late January.

Mr. Flaherty has been set up as the fall guy, and there doesn't seem to be a back-up plan in place if his government doesn't supply the money.

It's a game of brinkmanship: No money, no deal and the whole market will crash, with Ottawa as the scapegoat.

Last year at this time, the committee was looking for a $14-billion margin funding facility, squeezing Canadian and foreign banks and were rebuffed by Ottawa, which wanted a private-sector solution.

The committee insists the $9.5-billion is merely a security blanket and won't likely be needed, as it will first call on the $39-billion in margin facility and collateral already in place. The committee is even willing to pay for it, and it will be drawn upon only if all existing available collateral has been fully utilized.

That's funny, too, because a year ago, the committee felt it needed only $14-billion; now it needs $23.5-billion. The worst of the recession could still be in front of us, so there's no guarantee the $9.5-billion facility won't be called on in the coming years.

It raises the question, at a time when auto companies are close to failing, investors have taken major hits to their own investment portfolios, and a crashing economy is all around us, is this the right place for the government to be putting its money? In a facility that will largely pay out foreign banks if it's called upon.

Before he makes his decision, Jim Flaherty should read the Investment Industry Regulatory Organization of Canada report on the failure of the ABCP market. It's stunning in its damnation of investment dealers, which IIROC oversees, and their role in ABCP. It reveals the inherent conflict and unfairness at play when the market blew up.

At the time of the crisis, 14 securities dealers held positions in ABCP. Seven immediately paid out clients to the tune of $319.7-million. Three others have compensation plans to pay investors $177-million if the deal closes. That includes Canaccord Capital Corp. and Credential Securities, part of the credit unions, both of which sit on the committee overseeing this restructuring.

What's concerning is the different hats everyone wore. At one point, 26 dealers were involved in the manufacturing and distribution of this paper.

When you look at the ownership of ABCP sponsors, it's rife with conflicts. Pension plan Caisse de depot et placement du Quebec was a part owner in the pioneer behind the nonbank ABCP market, Coventree Inc. National Bank played an important role. (IIROC was unable to obtain information about ownership in one of the companies involved.) When it came to ABCP distributors, there were nine dealers and four banks. You get the picture. They had their hands in every part of this market.

The report cites "significant gaps" in the oversight of ABCP by dealers: failing to disclose information, no detail as to underlying asset classes in the paper, lack of due diligence into the products they were selling, and no training. The list goes on and it's appalling.

The Ontario Securities Commission and IIROC have tools to make people account for such action. The OSC can seek a court order and ask for the transactions to be rescinded.

It's time OSC chairman David Wilson and IIROC president and CEO Susan Wolburgh Jenah flexed their muscle in this restructuring. They've been noticeably absent in this mess, which happened on their watch. They need to be part of the solution and should be leaning on the investment dealers to take this back on their books and make investors whole. They then can fight it out among themselves over who's liable. Failing that, the banks and dealers should put up the $9.5-billion to sort out the mess they created.

Jim Flaherty shouldn't be the one to wear this.

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