The European asset backed commercial paper sector has scarcely scraped through the past two years.
Like a miners canary, months before most other markets experienced a crisis, and before Lehman Brothers became a household name for all the wrong reasons, a liquidity crisis hit the sector as structured investment vehicles went into meltdown and investors shunned any product with the words "asset backed" in its description.
European ABCP outstandings fell from a peak of $285bn equivalent at the end of July 2007 to $47.4bn at the end of November 2009, according to Dealogic data, with the share of total ECP outstanding falling from 35.2% to 7.4%.
But after falling consistently through the second half of 2007 and the whole of 2008, the sectors outstanding paper remained quite constant throughout 2009.
"The ABCP market has had a period of stability," says Peter Eisenhardt, chairman of the International Capital Market Associations European commercial paper sub-committee. "It has hit its low."
The decline has been, at least partially, due to the recession.
"The core level of issuance is still declining but this is mainly linked to the state of the economy and the fact that there is less use by the underlying corporates of financing through CP," says Sophie Berthelon, senior vice president of the structured finance group at Moodys in Paris.
Though some conduits have disappeared from the market, the situation is not entirely bleak.
"There have been a couple of programme terminations, where sponsors have thought it no longer worthwhile maintaining their programmes," says Emma-Jane Fulcher, head of ABCP for EMEA at Fitch in London. "But they have been few and far between. There will likely be more but it hasnt been as bad as it could have been."
There are those who believe that the market has improved recently.
"From a European perspective, investors have returned to buying and durations have increased from overnight through to one month or three months," says David Wright, head of European conduit origination at Royal Bank of Scotland. "High quality ABCP conduits have gone back to pre-credit crunch levels of execution off the back of strong demand."
Gail Le Coz, chief executive of the Institutional Money Market Funds Association, which represents around Eu430bn of assets in triple-A rated money market funds, agrees that maturities are lengthening.
"Some investors are now purchasing high quality ABCP," she says. "And durations are starting to lengthen, following the constriction towards the really short end during the crisis."
ABCP conduits have also experienced improved spreads.
"In terms of pricing the market has eased," says Marc Nocart, co-global head of securitisation at Société Générale. "The best issuers are more or less at pre-crisis levels."
Many fund managers maintain that they would look at the product, but are still subject to the whims of their end investors. "Asset managers are now fine with ABCP, at least for multi-seller conduits," says Nocart. "But the end users still need to be convinced that these are safe instruments."
The only likely way around this is through improved investor education, as well as a decline in bad headlines and stigma, and there are positive signs in this direction."
"Weve got research requests from some investors, and this shows they are trying to do their homework again," says Berthelon. "And we have been told that issuers are starting to market their programmes again and have refined their strategy."
The US market offers a brighter picture than its European counterpart.
Although its ABCP outstanding, having fallen from a high of $1.17tr at the end of June 2007, continued dropping throughout last year from $704bn at the end of 2008 to $500bn at the end of September 2009, according to Morgan Stanley, it continues to make up a large proportion of overall USCP outstanding roughly 43%.
In addition, the sectors rate of decrease has recently slowed.
Some believe the markets better performance is due to greater sophistication.
"If you look at Europe and the US, both markets have suffered a lot in terms of outstandings," says Reiner Ulrich, head of ABCP conduit management at UniCredit Markets & Investment Banking in Munich. "But the higher drain is definitely in Europe. It seems that the market has never been as developed and educated as the US."
The more positive tone in the US has enabled some European conduits to return to issuance.
"One reason for the small size of the ECP market is that all the sponsors are issuing in the US market whether they are located in Europe or not," says Berthelon. "Around 70% of CP issued by European conduits rated by Moodys is issued in the USCP market."
Issuers have benefited from ever-tighter spreads in the US.
"Spreads in the USCP market for particular programmes have come right down, which has helped issuance there," says Fulcher. "Some programmes are getting sub-Libor again. With the swap rate as well, its cost-effective to continue maintaining these programmes."
SocGen has pursued this path. "Our conduits are mainly issuing in the US now, even the European ones," says Nocart. "European assets offer diversification for asset managers."
The US markets swifter recovery has been helped by state support. Wright believes that the Federal Reserve deserves praise for the programmes it implemented in 2008 the Commercial Paper Funding Facility (CPFF) and the Asset Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF).
"The Federal Reserve understood the scale of the situation," he says. "It grasped it quickly and put in place a very effective programme to restore confidence in the market."
Ulrich agrees. "The CPFF for issuers and AMLF for investors were major contributors to the markets survival," he says. "There was a lot of restructuring and some conduits exited, but many were able to go ahead and keep funding. We did not have much support in Europe, as the regulators seemed to have some difficulties coming up with a common approach."
One initiative that has been introduced in Europe has been the Bank of Englands secured commercial paper facility.
At the end of July, the Bank revealed details of its scheme to support the sterling asset backed commercial paper market, but it was greeted with a collective shrug of the shoulders from unimpressed structurers and dealers who gave the programme little hope of success because of its stringent criteria.
To date, no conduits have taken advantage of the scheme.
"Knowing its there is helpful," says Eisenhardt. "But limiting the conduits to UK-relevant client assets was difficult because thats really not how conduits operate. And for some it would have taken the building of a brand new conduit to make it work, and that takes time."
The facility may yet be used in 2010.
"There hasnt been any usage under the Bank of England facility, but there may be some programmes set up to access that facility in the beginning of 2010," says Fulcher.
The greatest threat to ABCPs prospective recovery comes from impending and potential regulatory changes, such as the proposed rules published in July by the Basle Committee on Banking Supervision and the European Commission, which modified proposals originally put forward last January.
"Unfortunately I think its a big threat and a big unknown, because there are many parts still under discussion," says Berthelon. "Some banks appear to be clearly committed to keeping their ABCP conduit, but might want to change to full support if it is deemed better for capital treatment. Others may decide its not worth it, depending on the size of the conduits and their business model. Thats something that might reduce the market size further."
The new guidelines largely eliminate the regulatory capital advantages of setting up a conduit. Both multi-seller and securities-arbitrage conduit sponsors will likely face higher capital charges, particularly for providing programme-wide credit enhancement (PWCE).
The proposals will probably have a much bigger effect on securities arbitrage conduits because of the greater likelihood that both the liquidity and PWCE facilities are considered resecuritisation exposures, which face higher capital charges than normal securitisation exposures.
The new guidelines will likely result in some conduits winding down, while others may be less affected or may restructure to survive.
The Basle II rules also expand on the original proposal regarding "self-guarantee" exposures. A bank would not be able to recognise a rating on an exposure where the rating is largely dependent on a guarantee it provides.
This is supposed to prevent capital arbitrage on back-door liquidity support, where a bank buys ABCP from a conduit it sponsors rather than drawing down on the liquidity facility it provides.
As the paper is rated, the bank had been able to enjoy a lower capital charge than if the conduit had drawn down on the liquidity facility. This arbitrage will be eliminated under the proposals.
Nevertheless, some banks may continue buying ABCP issued by conduits they sponsor to enter into repurchase agreements with central banks.
Although the changes will probably mean the end for some conduits, market participants expect traditional multi-sellers to remain a viable source of funding.
"It could be the end of the security-backed programmes," says Fulcher. "However, there arent many securities programmes left anyway, so its unlikely to have a massive impact on ABCP. There is going to be an impact on multi-sellers, and some sponsors are going to reanalyse whether its cost-effective to maintain these programmes. But the majority say they will, because it provides diversification of funding. Most of the cost associated with multi seller-conduits is passed on to the underlying borrower, so whether banks will also put their capital charge into that and pass that on is yet to be seen."
Many believe that regulators are going too far and acting reflexively.
"The major problem over the last two years was that everything labelled asset backed was perceived as toxic," says Ulrich. "Many market participants seem to be trying to overcompensate for the past and do not differentiate anymore."
But it is not only banks that face fresh regulation. Investors could also be impeded from buying ABCP if certain proposed regulations are introduced.
The Committee of European Securities Regulators (CESR) had a consultation open until the end of 2009 asking market participants what constitutes a money market fund, to establish pan-European standards. Among the concerns is whether a money fund should invest in ABCP.
"In Europe there could be a big impact from the proposals regarding money funds," says Fulcher. "If they go through and restrict money market funds from buying ABCP, it will damage the recovery of the European ABCP market, because the main investors into the sector have been the big money market funds."
Investors are unlikely to support an outright ban on ABCP. "We dont know where CESR is going to end up on this question," says Le Coz. "However, to the extent that our managers are still investing in ABCP, as long as the paper meets the other guidelines that CESR is requesting to limit the interest rate risk, to limit the credit risk, etc we feel that the managers should be allowed to continue purchasing high quality ABCP."
Comeback on hold
With all the challenges the sector has faced and has yet to face, is there hope for a real resurgence? The decline in conduits is unlikely to be reversed soon.
"It costs money to start conduits and to run them, and sharp changes in strategy probably dont make sense," says Eisenhardt. "A number of conduits have disappeared, but maybe they were the wrong type of structure. Some banks will consolidate their conduits if theyve been through a merger; its a fair assumption that banks that have merged may not be looking to have too many conduits and will consolidate them."
It is clear that some conduits have no hope for the future. "SIVs are gone forever, and security arbitrage conduits are not in favour for now," says Eisenhardt.
But multi-seller conduits should at least continue to exist. "It is likely that multi-seller conduits are here to stay," says Berthelon. "Its just a matter of banks offering disintermediated financing to their clients."
Ulrich agrees that a back-to-basics movement is underway. "The entire business started off with trade receivables, and this is obviously the product of the future multi-seller structures with trade receivables," he says. "Many of the products that emerged during the last couple of years seem not to have a future, at least not in the near term. Investors want to see a transparent approach with easy structures and classic assets they can understand easily."
Wright believes that investors will persist with similar demand to now.
"There is a strong and healthy future for the multi-seller conduits sponsored by high quality banks with diverse asset pools and good quality reporting," he says. "Theres strong demand at the moment, and we certainly think that there will be strong demand for that going forwards. Investors may discriminate against some of the conduits that perhaps dont tick all of those boxes."
In addition, those conduits that do persevere may see an increase in activity as economic recovery spreads.
"Arbitrage conduits are not encouraged by regulators," says Nocart. "But the remaining multi-sellers are fully legitimate and fund the real economy, so activity will be correlated to real economic activity. So our view is that it will start to increase, but at the pace of the global economy."
Wright also believes that an economic recovery could lead to an ABCP recovery, though it may not be imminent.
"Outstandings may continue to drop slightly while the effects of the recession continue to work their way through the system, but on the flip side, as the economy recovers, more activity means more receivables to be securitised and that will help offset some of those negative factors," he says. "So its going to be a slow process, but I expect stabilisation in the near to medium term."
But some doubt whether any increase in European activity can be expected.
"Theres clearly a huge demand in the US versus supply that can be provided by the conduits," says Stéphane Hubert, director, conduit and risk management at Société Générale. "Given the feeling of better reliability in the US versus Europe, Im sure that an increase in volume will not go to the ECP market. In fact, I think it will continue to shrink."
Fulcher draws a parallel to another market, reasoning that there may yet be some improvement in Europe.
"In the South African ABCP market, the buyers that remained reduced the size of their investments," she says. "But theres more enquiry coming back, and investors are beginning to look at ABCP as a product again. Its only a matter of time before that happens in Europe, but investors have to get their senior management and end investors to understand ABCP."
She emphasises that, if there is to be any resurgence, investor education is the key."Of the programmes that we rate in Europe, there havent been any losses to investors; so its just trying to get that message across. Once that finally sinks in and they finally see how these programmes work, they will begin to come back." o