The reliance of asset-backed commercial paper conduits (ABCP) on liquidity agreements with banks means they will be affected by Basel III’s proposed liquidity coverage ratio (LCR).
In a recent report, Fitch Ratings said that cost increases to ABCP provoked by Basel III’s requirements has pushed these vehicles to develop alternative liability structures that seek to shorten the window of the LCR net cash outflow exposure.
They’ve done this by issues notes that are callable, puttable-callable and are extendible by investors.
“ABCP sponsors are essentially creating liabilities that would allow them to reduce the number of days over which they would be required to calculate expected cash outflows,” said Senior Director Kevin Corrigan. “In turn, they are reducing the liquidity costs associated with those outflows.”
The LCR test imposed by Basel III requires banks to demonstrate they have enough high-quality, liquid assets to meet all their funding requirements over a 30-day timeframe, according to Fitch.
The response by banks, the agency said, has been to create “liabilities that would allow them to significantly reduce the number of days over which they would be required to calculate an expected cash outflow related to each outstanding note.”
An example is a conduit that issues a note that comes due in more than 30 days but redeems it no later than the 30th day thanks to a call feature. Such a scenario could, in Fitch’s opinion, reduce the cash outflow calculation to one day.
The agency expects these new instruments to gain traction as investors grow more comfortable with them. So far, a number of ABCP conduit sponsors have amended program documentation to allow for the issuance these new instruments, but few have actually rolled them out. Fitch thinks that will soon change.
The sector could certainly use a boost. Since the crisis, outstanding paper has plunged 75% from a highpoint of $1.2 trillion in July 2007 to $269 billion in June 2013.