Saturday, January 24, 2009

Canadian regulatory response to the ABCP crisis

On October 6, 2008, the Canadian Securities Administrators (CSA) issued a Consultation Paper outlining several securities regulatory proposals related to the Canadian non-bank sponsored asset-backed commercial paper (ABCP) market.

Shortly after events in international credit markets led to a seizure of the non-bank sponsored portion of the ABCP market in Canada, the CSA took a number of immediate steps, which included the formation of an ABCP working group to address securities regulatory issues stemming from the credit market turmoil. Those issues are examined in the CSA Consultation Paper.

“In the process of developing these proposals, we considered numerous complex issues, worked with international securities organizations, and closely monitored international developments,” said Jean St-Gelais, Chair of the CSA and President and Chief Executive Officer of the Autorité des marchés financiers (Québec). “We believe that the proposals reflect a measured regulatory response that address our investor protection mandate and are appropriate for the Canadian marketplace.”

The CSA Consultation Paper contains proposals and solicits comments on a number of questions related to the proposals for:

Implementing a regulatory framework applicable to credit rating agencies that would require compliance with the recently amended code of conduct established by the International Organization of Securities Commissions (IOSCO). In addition, the CSA is considering requiring public disclosure of all information provided by an issuer that is used by a credit rating agency in rating an asset backed security.;

Amending the short-term debt exemption to make it unavailable for sales of asset-backed short-term debt including ABCP. This would require issuers who sell these products to do so by way of prospectus, or under another exemption;

Reducing reliance on the use of credit ratings in securities legislation;

Addressing the roles played by dealers and advisers with respect to ABCP; and

Reviewing specific issues regarding mutual fund investments in ABCP.
The CSA continues to work closely with the international community, and is an active participant in two IOSCO task forces dealing with matters relating to the credit market turmoil. The CSA also continues to monitor international developments, including initiatives led by the U.S. Securities and Exchange Commission, the Committee of European Securities Regulators, the Financial Stability Forum and the U.S. President’s Working Group on Financial Markets.

The Consultation Paper, which is available on the websites of various CSA members, is open for public comment for 75 days. The comment period closes on February 16, 2009. (Until November 28, the deadline had been December 20, 2008.)

Here are some excerpts from the proposal:

The distribution of ABCP in Canada is typically exempt from the registration and prospectus requirements under the short-term debt exemption in section 2.35 of NI 45-106:

2.35(1) The dealer registration requirement does not apply in respect of a trade in a negotiable promissory note or commercial paper maturing not more than one year from the date of issue, if the note or commercial paper traded:

(a) is not convertible or exchangeable into or accompanied by a right to purchase another security other than a security described in this section, and

(b) has an approved credit rating from an approved credit rating organization.

The Committee proposes amending the current short-term debt exemption to make it unavailable to distributions of asset-backed short-term debt.

The impact of the Credit Turmoil has raised a number of issues specific to mutual funds. Our research showed that some retail money market funds were exposed to non-bank sponsored ABCP that was frozen in August 2007. A few of these funds held close to 10% of their net assets in one non-bank sponsored ABCP issuer. Three retail equity funds held almost one-third of their net assets in non-bank sponsored ABCP as cash cover for derivative positions entered into by the funds.

Under NI 81-102, a mutual fund must meet certain criteria to call itself a money market fund. The definition of “money market fund” limits the types of investments that the fund can make, the term to maturity of those investments (which must be 365 days or less) and the dollar-weighted average term to maturity of the entire investment portfolio (which must not exceed 90 days). In addition, retail mutual funds (including money market funds) are prohibited from investing more than 10% of their net assets in any one issuer.
ABCP that has an “approved credit rating” is an eligible investment for money market funds. Therefore, a money market fund could invest up to 100% of its assets in ABCP of 10 different ABCP issuers, if all the ABCP had an “approved credit rating”.

[An "approved credit rating" means a rating at or above one of the following rating categories issued by an approved credit rating organization for that security or instrument. The currently-approved credit rating organizations are DBRS, Fitch Ratings, Moody’s and S&P, and the short-term debt rating thresholds are, respectively, R1(low), F1, P-1 and A-1(low). (NI 81-102)]

The Committee proposes to review whether a concentration restriction in NI 81-102 for money market funds is appropriate, and if so, whether the current 10% concentration restriction is appropriate, [and] whether to further restrict the types of investments (such as asset-backed short-term debt) a money market fund can make.

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