The Volcker Rule’s treatment of asset-backed commercial paper conduits (ABCP) will motivate sponsors of these conduits to provide full unconditional liquidity coverage and remove an important regulatory risk from the sector, Fitch Ratings says.
The final rule released this week prohibits banks from acquiring or sponsoring “covered funds,” and ABCP conduits, which issue short-term debt backed by assets such as trade receivables, consumer debt receivables, or auto and equipment loans and leases, would normally be classified as covered funds. In order to be exempt from the definition of a covered fund, these conduits must be fully supported by a bank. That means the bank must agree to step in and repay maturing commercial paper issued by the conduit in the event of losses in the underlying assets.
Currently, not all banks with ABCP programs provide full support, according to Fitch; some provide 'partial support' contracts where they advance cash to commercial paper holders in the event of mismatch of the timing of interest payments on the collateral and payments on the commercial paper. But partial support contracts do not obligate banks to make good on defaulted assets.
In a report released today, Fitch said that partially supported programs will need to be restructured to be excluded from the rule’s definition of a covered fund. The rating agency expects they will convert to full support at the conduit or individual transaction level over the next several months.
“As many sponsors have already taken steps this year to comply with other regulations, we expect the vast majority, if not all, to restructure so they can be exempted,” Fitch stated in the report. “Many sponsors have already restructured to issue under different legal exemptions and developed the ability to issue liabilities in addition to traditional ABCP-like callable, putable and investor-option extendible notes for liquidity coverage management purposes.”
While the final rule removes one regulatory risk, a number of regulatory obstacles that are largely out of conduit operators’ control will likely keep a lid on growth in the sector in the coming year. As of Nov. 30, 2013, U.S. ABCP outstandings stood at $250 billion on a nonseasonally adjusted basis, according to the Federal Reserve. That was an 18% decline from year-end 2012 level and 80% lower than the peak of $1.2 trillion in July 2007.
