Asset-backed commercial paper has become a boring, plain vanilla product—so what’s with all the regulation?
That was the question posed by panelists at Information Management Network's ABS Vegas conference.
Credit Agricole Managing Director Sam Pilcer said the product “funds mainstream America” and that even issuers that have easy access to the bond market - like Ford - find value in this alternative source of funding.
The short-term instrument has moved away from funding risky assets, like subprime mortgages, that were at the center of the ABCP crash after the July 2007 peak. Pilcer said on a panel on Sunday that currently ABCP isn't funding any assets that would be considered abusive or controversial and yet the industry is weighed under "a ton of regulation.”
Reviling those regs as a "wheel of torture," panelists said they don't reflect the fact that for the last seven years, ABCP has been a plain vanilla product.
Denis Dillon, a partner at Hogan Lovells, spoke on the risk retention rule and liquidity-coverage-ratio (LCR) requirements under Basel III that will shape the market. The risk retention rules - designed to ensure issuer have skin in the game by exposing them to certain losses - have been in place in Europe since 2011. In the US, the rules won’t apply to ABCP until 2016.
“There is a big difference in how rules apply to U.S. and European conduits,” said Dillion. For example, in Europe liquidity support is considered risk retention but the U.S. does not allow the same contingent form of retention for ABCP programs here. Conduits operating in Europe and the U.S. will have to comply with both regulatory regimes.
In December, Moody’s Investors Service published a report on the funding tool and the different ways conduits can approach the risk retention rule. The rating agency said that in fully supported conduits, liquidity providers, which typically also assume the role of sponsor, could easily retain the required 5% of the CP as they already effectively retain 100% of the risk. The vast majority of ABCP are bank-sponsored and either fully or partially supported by the sponsor in the event of defaults.
Sponsors can retain risk by holding a “horizontal” interest in the most junior tranche; holding a “vertical” slice, that is, 5% of each tranche of the program’s paper; an approach that combines the two; or, particular to ABCP, ensure the conduit’s customers keep the 5% of the assets being funded.
The LCR rule, which kicks in this year, is designed to ensure banks will have enough funds available to cover its commitments in periods of stress; the LCR has pushed ABCP conduits to allow for the issuance of puttable and callable paper. The idea is to minimize the burden of holding funds under the LCR calculation.
Amid these regulatory challenges, the market has already responded by creating collateralized commercial paper vehicles (CCP), a product that capitalizes on the fact that commercial paper has been a strong liquid product over the last seven years, said Barclays Director Stewart Cutler, who also spoke on the panel. The instrument is an asset-backed security targeted to prime money-market funds, a popular short-term investing vehicle for treasurers.