Monday, February 23, 2009

ABCP needs transparency, disclosure: SIO

By Doug Watt.
Originally published on

The route to regulatory repair of Canada's besieged asset-backed commercial paper (ABCP) market is through mandated transparency and disclosure, according to a submission on the recent ABCP crisis by the Social Investment Organization (SIO), the national association for socially responsible investment.
Canada's $35 billion non-bank ABCP market ground to a halt in August 2007, largely due to concerns over the collapse of the U.S. sub-prime mortgage industry. A massive restructuring effort led by Purdy Crawford was finally completed in January, bringing the 17-month saga to a close.
Last fall, the Canadian Securities Administrators asked for comments on new regulatory proposals related to ABCP.
"We believe that the root cause of this market failure was a lack of transparency and disclosure by the issuers of ABCP in Canada, particularly with regard to the non-financial aspects of the underlying assets," says SIO executive director Eugene Ellmen.
Although sub-prime mortgages were a small part of the Canadian ABCP market, the panic they generated in the U.S. led to a crisis in confidence in the overall credit markets, affecting other structured products, such as collateralized debt obligations and credit default swaps.
Ellmen notes that some industry observers, such as Innovest Strategic Value Advisors, identified weaknesses in the credit market based on environmental, social and governance (ESG) issues as far back as 2006. "The analysis conducted by Innovest in a review of bank credit markets found that rising home ownership combined with lower real wages was putting the sub-prime mortgage market at real risk."
In hindsight, Ellmen says, these non-financial or ESG risks posed significant threats to the safety of the credit markets. "So we have to ask ourselves why these risks were not properly identified by the market and priced into mortgage-based securities and other structured finance products such as ABCP."
The SIO believes that if these risks had been properly disclosed and the information disseminated into the market, many analysts and investors would have been reluctant to purchase ABCP, reducing liquidity for these instruments and mitigating the impact of their subsequent collapse.
"The underlying risk of sub-prime mortgages was an ESG risk, not a financial risk," Ellmen concludes in his submission. "The lack of a disclosure framework prevented analysts and investors from incorporating such risks into their assessment of asset-back securities, resulting in a disastrous over-subscription to this market."
The SIO recommends that issuers or originators of ABCP should be reporting issuers, subject to prospectus and continuous disclosure requirements, which should include material environmental, social and governance risks, as well as key performance indicators to enable analysts and investors to assess the non-financial aspects of such offerings.
"ESG policies and practices should be outlined in the annual information form and the management discussion and analysis as part of the continuous disclosure requirements."
The SIO also suggests that while credit rating agencies, which took a share of the blame for the ABCP crisis, should be subjected to a regulatory framework, mandated disclosure of information from issuers to the rating agencies should not a be a part of this framework.
"The role of credit rating agencies is to assist investors in making a decision about a credit product, not to release all the relevant information on that product into the market. Markets only operate efficiently if issuers release all material information on their securities through a continuous disclosure basis."

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