Asset-backed Commercial Paper Research Articles

Market discipline and regulatory arbitrage: Evidence from ABCP liquidity guarantors

We investigate whether the U.S. stock market disciplines asset-backed commercial paper (ABCP) liquidity guarantors who exploit a regulatory loophole that exempts at least 90% of the risk capital charge. We find that the market reduces liquidity guarantors’ franchise value when a short ABCP maturity causes the conduit credit losses to remain with guarantors rather than being transferred to investors. Banks with franchise value more sensitive to the ABCP guarantee cost maintain a higher risk capital buffer. We interpret our findings as evidence that market discipline–complexity of the shadow banking system notwithstanding–alleviates the consequence of regulatory arbitrage.

The European banks’ role in the financial crisis of 2007-8: a critical assessment

ABSTRACT Since the outbreak of the financial crisis in 2007, opinion has been divided over whether its root cause was weak regulation and bank funding problems or the pressure of investor demand for US safe assets. New research on the European banks’ role in the crisis may finally help to resolve the issue. Far from being peripheral players in the crisis, European banks were deeply implicated in its causal origins as evidenced by their activities in the two US debt markets that were at the heart of the crisis: those for collateralised debt obligations (CDOs) and for asset backed commercial paper (ABCP). These activities would seem to lend weight to the conclusion that regulation and bank funding issues were the key causal variables in the financial crisis. However, it is a conclusion only made possible by ignoring the pre-crisis connection between the federal funds rate and the rate of ABCP demand from the institutional money market mutual funds (MMMFs). This paper argues that when this connection is closely examined, it turns out that the evidence surrounding the European banks’ role in the financial crisis gives greater weight to the safe asset demand explanation of the crisis.

Broken bucks: money funds that took taxpayer guarantees in 2008

This is the first study to look at the characteristics of funds accepting the $2.7 trillion taxpayer guarantee of money market mutual funds during the 2008 financial crisis. Fund shares that benefited from Federal Reserve’s asset-backed commercial paper program were significantly more likely to get bailed out by taxpayers and sponsors. The paper tests if funds adhering to the SEC’s 2010 liquidity reforms prior to their enactment were less likely to be bailed out in 2008. Finally, it examines if funds subject to the 2014 floating NAV regulations were more likely to be bailed out in 2008.

Filling the Gap: Emergency Funding Programs and Asset-Based Finance in Times of Economic Crisis

The value in 2018 of vehicles and equipment for consumer and business customers in Canada financed by the asset-based finance (ABF) industry was an estimated $416 billion. The ABF industry supports a broad network of dealers, manufacturers, distributors, vendors and brokers, and their customers throughout the country. ABF is offered by banks, credit unions, insurance companies, government financial institutions, manufacturer finance companies, and independent finance companies. Several of these entities are regulated with consequent access to existing Bank of Canada programs for emergency lending. This paper focuses on those entities – both regulated and unregulated – that may not have such access, and yet are critical to the functioning of the economy. ABF entities ran into deep trouble during the 2008-2009 global financial crisis and required an emergency liquidity program from the federal government that took months to devise and implement. The primary source of funding of the ABF sector was, and is, the asset-backed commercial paper and securitization markets, often with bank back-up or standby lines, purchased by private pools of investment capital – insurance companies, pension plans, hedge funds, banks and others. The 2008-2009 experience revealed that a complete loss of liquidity could occur within a few weeks, even days. Government was needed to step into the shoes of absent private-sector investors. Given the ABF industry’s relative success and low delinquencies, this Commentary recommends that, during periods of extraordinary financial market turmoil, the federal government activate a large-scale securitization program that would fund ABF intermediaries who finance customers based on real assets. The government would purchase asset-backed securities backed by a pool of assets and their receivables, receiving the same protection and profit that a privatesector investor would receive. Once liquidity is restored and private investor confidence returned, the commercial markets would again resume their normal functioning and government could withdraw its scaled-up temporary emergency funding program. The 2009 Federal Budget established the Canadian Secured Credit Facility, a $12 billion fund administered by The Business Development Bank of Canada (BDC) to purchase term asset-based securities (ABS) backed by loans and leases on vehicles and equipment. Since then, under successor programs, the BDC has continued to purchase ABS albeit on a smaller scale. With more than 10 years of experience, the BDC understands the policies and rules for such funding. Existing BDC programs could, therefore, be scaled up in a severe downturn, with experienced people in place for effective, prudent and efficient funding. In a profoundly disrupted market, the policy objective should be to restore liquidity to allow the financial services sector to continue offering financing to credit-worthy consumers and businesses in support of the Canadian economy, and that must include the ABF industry.

Revenge of the Steamroller: ABCP as a Window on Risk Choices

We empirically examine financial institutions' motivations to take systematic bad-tail risk in the form of sponsorship of credit-arbitrage asset-backed commercial paper vehicles. A run on debt issued by such vehicles played a key role in causing and propagating the liquidity crisis that began in the summer of 2007. We find evidence consistent with important roles for both owner-manager agency problems and government-induced distortions, especially government control or ownership of banks.

Revenge of the Steamroller: ABCP as a Window on Risk Choices*

Abstract We use credit-arbitrage asset-backed commercial paper vehicles as a laboratory to empirically examine financial institutions’ motivations to take bad-tail systematic risk. By comparing the characteristics of global banks that sponsored credit-arbitrage vehicles prior to the global financial crisis to those that did not, we show that owner–manager agency problems, government safety nets, and government ownership of banks are associated with bad-tail systematic risk-taking. Although good governance is associated with less risk-taking on average, well-governed banks that also have a high ex ante expectation of being bailed out by the government take more risk. Lastly, we find mixed evidence that tougher bank capital regulation deters bad-tail risk-taking.

Bank lines of credit as contingent liquidity: Covenant violations and their implications

We examine the relation between banks’ liquidity risk and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the asset-backed commercial paper (ABCP) market in the last quarter of 2007 and the first half of 2008, banks with higher exposure to ABCP conduits renegotiated significantly tougher conditions on the outstanding credit lines offered to borrowers in violation of a covenant. Specifically, we find that borrowers faced higher spreads over the prime rate and LIBOR as well as higher commitment fees on undrawn amounts. Our paper suggests that an increase in lender liquidity risk can bear financial implications for firms that use credit lines as an instrument of liquidity management.

Lights on the shadows: exploring the need for regulation in shadow banking

Since the outbreak of the economic and financial crisis of 2007-2008, the shadow banking system gained attention and caused concerns among standard setters, policy makers, and academics. This research is aimed at analysing the growth of the shadow banking system and assessing whether and how shadow banking entities should be further regulated. Using an instrument-based definition we infer the need for regulation in the shadow banking system by directly investigating the time series of asset backed commercial paper (ABCP) and securitised real estate loans (SREL). By means of several advanced and refined econometric tests, we explore time series data and find a non-stationary trend. This provides support for the need to regulate shadow banking. Further policy implications are discussed in detail.

The explosive growth of the ABCP market between 2004 and 2007: A “search for yield” story

The years immediately preceding the financial crisis of 2007 witnessed an explosive growth in the supplies both of the long-term securities issued by the shadow banking entities, the asset-backed securities (ABSs) and collateralized debt obligations (CDOs), and of the short-term securities issued by these entities, notably asset-backed commercial paper (ABCP). Although there is now some acknowledgment that the search for yield was the major driver of ABS and CDO growth in the United States, the same is not true of the U.S. ABCP market where other factors such as regulatory arbitrage on the part of banks or the safety and liquidity concerns of institutional investors are seen as having been the more important growth driving force. This article argues that the search for yield did play a crucial role in U.S. ABCP growth between 2004 and 2007. To back up this argument, the article points to four variables that were closely correlated with this growth: the federal funds rate; U.S. money market mutual funds asset holdings; the change in the geographical breakdown of the institutions supplying ABCP; and, finally, the change in the program breakdown of the ABCP market.

UK regulation of term securitization following a hard Brexit

The myriad asset classes and structures comprising the modern term securitization market (as opposed to bank-sponsored asset-backed commercial paper conduits) are all more or less complex variations on one theme: overcollateralized bonds. The bonds are typically issued on the credit of a segregated pool of financial collateral, not the credit of an operating company. Even though securitization documentation is more complex than that found in a typical corporate bond issue, securitization transactions are simpler and, arguably, more ‘scientific’ credits. That is because the underlying credit analysis is based on the aggregation of many small, broadly homogeneous credits or pools of credits that lend themselves to a quantitative credit analysis. The bonds usually are issued in tranches of different priorities, with the most senior tranche typically assigned a top, or AAA/Aaa, credit rating. Thus, a top-rated residential mortgage-backed security, or RMBS, with a face value of, say, 80 might be collateralized by residential mortgages with a principal value of 100. The structuring exercise makes possible funding at rates and maturities not otherwise obtainable in the fixed income market. For convenience, the rubric ABS, or asset-backed securities will also be taken to include RMBS and commercial mortgage backed securities, or CMBS.1

Reviving the Shadow Banking Chain in Europe: Regulatory Agency, Technical Complexity and the Dynamics of Co-Habitation

In recent years European financial regulation has experienced a tremendous reorientation with respect to the shadow banking system, which manifested first and foremost in its reframing as market-based finance. Initially identified as a source of systemic risk certain initiatives did not only fall much behind the envisaged changes but all to the contrary have been substantially modified in a way that they now aim at revitalizing these activities. The reorientation of European regulatory agency on shadow banking post-crisis, from curtailing it to facilitating resilient market-based finance, has been a cause for irritation by academic observers, dismissed by some as mere rebranding or taken as a sign of regulatory capture. All to the contrary, this paper documents the central role of regulatory agency in shadow banking’s reconfiguration. It does so by analyzing the European initiatives concerning the regulation of Asset-Backed Commercial Paper (ABCP) and another prime example of shadow banking, Money Market Mutual Funds (MMFs). Based on documentary analysis and expert interviews we trace the way the recently published EU frameworks for MMFs and ABCP have been designed (in particular the STS, CRR and MMF regulation in 2017). Furthermore, we show how they have been transformed in such a way that their final versions allow to re-establish the shadow banking chain linking MMFs, the ABCP market and arguably the regular banking system. This transformation is driven by a new form of pro-active European regulatory agency which aims at creating a regulatory infrastructure able to sustain the orderly flow of real economy debt. Far from being captured by the industry, they did so consciously and in cooperation with private actors in order to maintain a channel for credit creation outside of bank credit, a task made more complicated by the rushed politicized final negotiations coupled with technical complexity. This paper thereby contributes to a new strand of literature, seeing the creation and reconfiguration of the shadow banking system as characterized by the active and conscious role of state actors.

How Does Access to the Unsecured Debt Market Affect Investment?

This paper examines the relation between debt structure and investment, by exploiting differences in secured and unsecured debt holdings. In order to address endogeneity concerns, I exploit two sources of exogenous variation for identification. From the firms' side, the Jobs and Growth Tax Relief Reconciliation Act of 2003 represents a negative shock to firms' creditworthiness. From the credit market's perspective, the asset-backed commercial paper market collapse of 2007 caused a temporary shortage of unsecured commercial paper. Each of these shocks to debt structure is analyzed combining a difference-in-differences approach with an instrumental variable estimation (Waldinger (2010)), which allows studying i) substitution patterns among debt types and ii) the impact on investment. Results show that greater access to unsecured debt leads to larger investment. When firms face more restricted access to the unsecured debt market, they substitute toward secured debt, and reduce investment. The reason behind this result is that unsecured debt is more cost-effective in terms of spreads and covenants. These findings suggest that collateral is not key to finance investment, as instead has often been claimed in the literature. Creditworthiness rather than collateral is key to access unsecured debt. Additionally, I shed light on how access to the unsecured debt market relates to the balance sheet and credit channels of monetary policy.

Investigating risk contagion initiated by endogenous liquidity shocks: evidence from the US and eurozone interbank markets

ABSTRACTThis paper investigates liquidity spillovers between the US and European interbank markets during turbulent and tranquil periods. We show that an endogenous model with time-varying transition probabilities is effective in describing the propagation of liquidity shocks within the interbank market, while predicting liquidity crashes characterised by changed dynamics. We show that liquidity shocks, originating from movements of the spread between the Asset Backed Commercial Paper and T-bill, drive regime changes in the euro fixed-float OIS swap rate. Our results support the idea of endogenous contagion from the US money market to the eurozone money market during the global financial crisis.

Financial Innovation and Institutional Voices in the Canadian Press: A Look at the Roaring 2000s

This corpus-assisted analysis examines seven Canadian newspapers from 2001 to 2008 in English and in French. It focuses on the speech that journalists reported when covering new financial instruments, namely collateralized debt obligations, credit default swaps, and asset-backed commercial paper. Eight years of news were surveyed with a concordancer and the data were analyzed using critical discourse analysis. The data show a wider range of voices in the English subcorpus when compared with the French. In both subcorpora, however, journalistic attitude was neutral and critical voices were deselected, while institutional voices such as those of banks were foregrounded. If polyphony is understood as the inclusion of an array of voices from the community, our study shows that the press was monophonic. Concurrently, our investigation of the Canadian press reveals that financial innovations were not covered until 2007, when credit derivatives started to falter.

Discussion

Discussion

Lights on the Shadows: Exploring the Need for Regulation in Shadow Banking

Using an instrument-based definition of shadow banking, we investigate the size and evolution over time of the shadow banking system. We investigate data on Asset Backed Commercial Paper and Securitized Real Estate Loan with an original approach. By means of several advanced and refined econometric tests, we explore time series data and find a non-stationary trend. This provides support for the need to regulate shadow banking. Further policy implications are discussed in detail.

Bank Lines of Credit as Contingent Liquidity: Covenant Violations and Their Implications

We examine the relation between the financial health of banks and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the Asset Backed Commercial Paper market in the last quarter of 2007 and the first half of 2008, banks with higher exposure to conduits renegotiated significantly tougher conditions on the outstanding credit lines offered to borrowers in violation of a covenant. Looking at the broader period of the financial crisis (2007-2010), we find that a worsening in financial health at banks led to a lower probability of waivers, following a covenant violation on a credit line. Our paper suggests that a worsening in financial conditions of lenders can bear financial implications for firms that use credit lines as an instrument of liquidity management.

Culprits or Bystanders? Offshore Jurisdictions and the Global Financial Crisis

ABSTRACT Questions have been raised regarding the role of low-tax offshore jurisdictions in the global financial crisis, based largely on evidence that many problematic asset-backed securities were issued from or listed in the Cayman Islands, Jersey, Ireland, and other ‘offshore’ sites. However, there has not been a systematic investigation of the offshore geography of crisis-implicated securitization. Here we fill this gap by constructing the first comprehensive jurisdictional map of the largest pre-crisis Asset-Backed Commercial Paper (ABCP) programmes, and examining the rationale for and impacts of this geography in detail. We show that offshore jurisdictions were disproportionately involved in producing the most unstable ABCP classes. However, this is difficult to explain in terms of the traditional role of offshore banking centres as sites for direct avoidance of onshore regulation and transparency. Rather, we propose a Minskian model of pre-crisis offshore ABCP production, wherein these jurisdictions specialized in alleviating incidental institutional frictions (eg double taxation) hindering onshore financial innovation. In this context, they could sometimes be legitimately described as improving the institutional ‘efficiency’ of financial markets; however, by facilitating the endogenous evolutionary instability of these markets, this apparently innocuous service had profoundly negative effects. This normative disconnect poses a conundrum for offshore reform.

Stitched on the Edge: Rule Evasion, Embedded Regulators, and the Evolution of Markets

While the role of laws and regulations in structuring markets is well established, it is less understood how rule evasion affects the evolution of markets or how the interaction between regulators and the regulated about the meaning of compliance influences this effect. The authors study this issue by looking at the development of the asset-backed commercial paper (ABCP) market in France, Germany, and the Netherlands from 1999 to 2009. In all three countries, this market involved financial innovations designed to evade regulations. The authors identify diverging trends in the ABCP market that are a result of whether and how regulators were embedded in the different interpretive communities that defined regulatory compliance, such embeddedness being dependent on their discretionary and sanctioning power as well as their expertise. Focusing on these regulatory networks that embed institutions in markets, they propose a synthesis of relational and institutional accounts of the embeddedness of markets.

Culprits or Bystanders? Offshore Jurisdictions and the Global Financial Crisis

Questions have been raised regarding the role of low-tax offshore jurisdictions in the global financial crisis, based largely on evidence that many problematic asset-backed securities were issued from or listed in the Cayman Islands, Jersey, Ireland, and other ‘offshore’ sites. However, there has not been a systematic investigation of the offshore geography of crisis-implicated securitization. Here we fill this gap by constructing the first comprehensive jurisdictional map of the largest pre-crisis Asset-Backed Commercial Paper (ABCP) programs, and examining the rationale for and impacts of this geography in detail. We show that offshore jurisdictions were disproportionately involved in producing the most unstable ABCP classes. However, this is difficult to explain in terms of the traditional role of offshore banking centers as sites for direct avoidance of onshore regulation and transparency. Rather, we propose a Minskian model of pre-crisis offshore ABCP production, wherein these jurisdictions specialized in alleviating incidental institutional frictions (e.g. double taxation) hindering onshore financial innovation. In this context, they could sometimes be legitimately described as improving the institutional ‘efficiency’ of financial markets; however, by facilitating the endogenous evolutionary instability of these markets, this apparently innocuous service had profoundly negative effects. This normative disconnect poses a conundrum for offshore reform.