Asset-backed commercial paper could play a vital role in filling a gap in Canada's short-term money market supply, now that the country's banker's acceptance (BA) market is poised to stop operating, observers say.
The financing is a solid alternative, because it is the second largest money market instrument that its private sector issues, with yields that are marginally higher than those of banker's acceptances, according to Andrew He, a director at Fitch Ratings, and Ian Rasmussen, a senior director at Fitch, who co-authored "Canadian ABCP Primer: Growing Position of Canadian ABCP with End of BAs."
At stake is a $90 billion in new business, potentially. Banker's acceptances constituted a significant segment of short-term Canadian dollar-denominated money market instruments, $90 billion, or 20% of the outstanding Canadian money market as of October 2023, according to the Canadian Alternative Reference Rate (CARR) working group.
Banker's acceptances have been supporting small and middle-sized businesses in Canada since 1962 and are the second-most prominent type of security in this market after Government of Canada Treasury bills, and account for a signification portion of the one-month maturity investable product.
In May 2022, however, Refinitiv Benchmark Services (U.K.) Limited (RBSL), the regulated entity that administered the Canadian Dollar Offered Rate (CDOR), announced that it would end the CDOR on June 28, 2024. Once that decision went into full effect in June, since CDOR are used to price banker's acceptances, and related facilities, the Bank of Canada said the BA lending model is bound to discontinue.
The undoing of BAs
The Canadian Fixed-Income Forum (CFIF), a senior level industry-wide committee established by the Bank of Canada to improve market practices, recommended phasing out CDORs in May 2022.
The CFIF came into existence in line with financial benchmark reforms implemented in Canada after the 2008-2009 financial crisis.
Canada is the only major country to retain the BA lending model that long. It is an old construct that has been -globally discontinued, according to "Primer on Canadian ABCP" published in June 2024 by the BA Transition Virtual Network (BATVN, one of the working groups formed by CFIF to review alternative products that support the transition away from BAs.
CFIF also brought together over 80 industry experts, including 30 buy-side investors, banks, dealers, issuers, asset managers, pension funds and insurers, to discuss BA replacements.|The resulting report, "Impact of CDOR Cessation on Bankers' Acceptance Market" noted that investors have varying liquidity, yield, term, credit quality, amount, and predictability of issuance needs, "which demand varying degrees of implementation complexity amongst potential BA substitutes," and planning.
It highlights that while financial issuers and borrowers prefer longer-term funding, money-market investors tend to prefer shorter-term investment instruments. "Consequently, it is unlikely that a single instrument will emerge to fully replace BAs in the one-month tenure, which constitutes the vast majority of BA issuance."
In addition, some money market investors governed by restrictive regulations may not be able to access new products. Hence, expansion of the investable money market universe in Canada, including through the development of new types of investment products, will play an important role in facilitating an orderly transition away from BAs after the CDOR cessation, according to the report.
Fitch analysts agree that no single instrument will wholly replace BAs, but ABCP is a strong candidate.
The case for ABCP
BATVN identified ABCP paper as a gainful BA substitute that "results in another type of money market product for investors."
ABCP provides competitive yield relative to unsecured corporate CP or BA, according to BATVN, and an improved risk profile. At maturity ABCP investors are repaid directly from the cash flows on the underlying asset pool, or if the ABCP is not fully refinanced, through a draw on the liquidity facilities provided by the ABCP's sponsoring bank.
Major Canadian banks typically sponsor ABCP, which are backed by diverse underlying assets such as auto loans, credit card receivables, and residential mortgages, allowing the ABCP market to potentially expand and partially fill the anticipated $90 billion gap stemming from the cessation of BAs issuance, Fitch analysts explained.
Traditional multi-seller ABCP programs represent nearly the entire Canadian ABCP market, which has reinvented itself since the crisis, according to Fitch.
Bank conduits issued these short-term notes at a discount so investors could profit at maturity. Terms vary from 30 days to one year.
Prior to the 2008-2009 financial crisis both banks and non-banks sponsored Canadian ABCP.
Non-bank sponsored conduits established by private third-party financial entities typically funded mortgages and consumer loans. By 2007, a significant portion of BAs secured esoteric assets, such as collateral debt obligations. Conduit sponsors could not access funds under their liquidity support facilities due to the unique provisions of Canadian-style liquidity arrangements, which required the occurrence of a general market disruption.
Further, analysts note, approximately $32 billion worth of non-bank sponsored ABCP could not be refinanced. That led to the 2007 Montreal Accord "to freeze and attempt to restructure this troubled segment of the market," and the cessation of the non-bank sponsored Canadian ABCP sector.
Bank-sponsored issuers survived the crisis. Today they provide significantly stronger protections to ABCP investors, according to Fitch.
All bank-sponsored conduits have adopted the Global-Style Liquidity (GSL) facility, an international norm that was not a standard practice in Canada. The "Big Six" banks dominate the Canadian ABCP market. According to Bank of Canada, its primary investors are asset managers, pension funds, insurance companies and hedge funds.
