The widescale adoption of commercial paper with a call option in Europe could provide an important fillip to the beleaguered euro commercial paper market.
EuroWeek can reveal that European banks have already begun printing callable CP in the US to help with their dollar funding, writes Craig McGlashan.
Deborah Cunningham, chief investment officer, global money markets, at Federated Investments, said that while flows are still small, this is expected to change.
"This is in its infancy," she said. "This has not caught on like a big storm yet but it will grow as the year goes on. It will spread to Europe and other currencies."
European banks have been adding call and put options to their commercial paper and asset backed commercial paper programmes as they search for ways to avoid costly capital charges set to come in with Basel III regulation.
These capital charges risk pushing ECP supply into a nosedive — bank ECP outstandings have already fallen nearly $70 billion since January 2011.
Under the Basel III liquidity coverage ratio — set to be phased in between 2015 and 2019 — issuers are required to hold extra capital for any funding they receive that matures in less than 30 days. That includes longer dated debt they already hold with a redemption date in less than 30 days.
However, introducing a call option circumvents the problem — removing a potential barrier to supply. "Supply was going to be cut back because of this rule so this gives extra supply in the short end," said Cunningham.
European bank ECP outstanding has fallen from $237 billion at the end of January 2011 to $170 billion today, according to Dealogic.
Callable CP is generally designed with a call option 35 days prior to maturity, allowing the issuer to call the paper before it reaches the 30 day time limit that makes it less palatable and more unprofitable because of the additional capital required.
However, a call option can also offer investors a nice increase in yield — something which the money market fund community is desperately in need of.
"It is generally being offered with a put option, so if as an investor I get uncomfortable holding the paper I can put it back," said Cunningham. "But if it doesn’t come with a put, I get a little more from a return perspective because of the option we’re giving back to the issuer."
The callable structure could be a lifeline to banks facing high capital charges as a consequence of the Basle III liquidity coverage ratio, which had threatened to stifle supply of short-dated paper.
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