Canada: A Note On The Asset Backed Commercial Paper Crisis

As everyone is now painfully aware, a liquidity crisis in the Canadian Asset Backed Commercial Paper ("ABCP") market commenced in August of last year, resulting in a number of large institutional holders of that paper putting together a rescue package. The package initially was called the "Montreal Accord" and has subsequently resulted in the filing of a Plan of Compromise and Arrangement ("Plan") under the Companies' Creditors Arrangement Act ("CCAA").

The concept of the Plan is to "term out" the affected commercial paper without, in the vast majority of cases, material reduction in value to any holder, provided they are prepared to hold the commercial paper to maturity. The ABCP market emerged because of a large demand from institutional investors and others for high-quality assets (as measured by rating agency criteria) with returns better than those of comparably rated government securities. Special purpose trusts were formed to issue short-term commercial paper to investors and use the proceeds to buy assets with the appropriate risk characteristics, resulting in yields consistent with the investors' expectations.

One of the issues that needed to be addressed within these structures was that the commercial paper was generally short-term in nature while the assets were longer-term. Liquidity facilities were arranged under which financial institutions agreed to provide funding to purchase commercial paper in circumstances where new investors were not available to cover any funding gap on the periodic turnover of the commercial paper.

In August of 2007, more investors wanted to sell their paper than wanted to buy and the providers of liquidity, by and large, were of the view that the circumstances required to take advantage of their liquidity facilities did not exist. The market froze. A lot of legal effort has gone into parsing the terms of the liquidity facilities and speculating as to whether "Canadian" as opposed to "global" language should have been used. That debate appears to be largely irrelevant as all of these markets have frozen, on both sides of the Canada/US border, regardless of the liquidity trigger events employed.

Historically, the types of assets purchased by these special purpose trusts were financial assets such as automobile leases, commercial mortgages, insured personal mortgages and other similar assets. Pools of these assets might achieve a credit rating higher than any individual asset because of the broad distribution of the payors of the assets both geographically and individually, and the existence of fairly reliable statistics on default rates for particular asset classes. However, the demand for ABCP outstripped the availability of these "traditional" assets and financial institutions began to assemble more exotic instruments that were intended to meet the necessary criteria.

Credit default swaps were often used to fill the asset gap for commercial paper. Indeed, traditional assets backed less than 20% of the estimated $30 billion dollars in ABCP that defaulted in August of 2007.

Credit default swaps used for these purposes were usually structured so that the protection seller was the special purpose conduit and the protection buyer was a financial institution. The protection being purchased was often protection against default of a slice of debt in a reference portfolio where the likelihood of default was extremely small, thereby meeting the rating requirements of the rating agencies. To satisfy the return requirements of investors, the credit default swaps were often significantly leveraged so that the protection seller would agree to pay 10 or even 20 times the default amount should default occur. After all, if the likelihood of default is so low that it is almost zero, ten times zero is still zero.

However, the risk of default was not zero and when the residential mortgage crisis occurred in the United States, it became clear that the lenders making the underlying loans had been overly aggressive in their lending practices. The potential for default in an asset category that had been quite small increased substantially. Not all reference assets in all the credit default swaps were related to residential mortgages, but some were and some of the debt obligations forming part of those reference assets were from entities engaged in the sub-prime mortgage market in some direct or indirect way and therefore were directly or indirectly affected by failures in that market place. Accordingly, the risk profile of the reference assets in the credit derivatives increased dramatically.

In the meantime, many credit derivatives were not fully funded. That is, the money raised from commercial paper offerings by the conduits and deposited with the protection sellers to cover the protection buyers' obligations, should a call be made under the relevant credit derivative, was not 100% of the amount that could theoretically be called. Sometimes the collateral amounted to 10% or less of the potential claim.

Under the derivative contracts, the protection seller's exposure is determined based upon what the protection seller would need to pay in order to replace the credit derivative that it has on its books. Accordingly, if on day one a protection buyer paid $0.20 for a million dollars in coverage for a super senior debt obligation having a notional amount of $10,000,000, but on day two that premium would only have purchased $5,000,000 of coverage, its exposure has increased by $5,000,000 and its collateral requirements increased accordingly. This relationship between market price and collateral resulted in significant shortfalls in the collateral underlying the credit derivatives backing the ABCP market.

The result is that if those collateral calls are actually made, all the cash that was contributed by noteholders will get swept up into the collateral calls. The credit derivatives will terminate and there will be no money to pay anybody except the investment dealers.

There are many other complex legal and accounting issues underlying the crisis, but the bottom line from a financial prospective is that the actual cash contributed by investors could easily melt away if the credit default swaps are permitted to terminate, without any actual losses being suffered.

It was not anybody's intention that the investors in ABCP should be left without any return on (or of) their investment, and it has been interesting to watch how these issues have been dealt with on both sides of the border. In Canada, at least so far, the CCAA has proven a very flexible forum in which to address the needs of a widely disparate group of investors and financial institutions resulting in a compromise which, while not to every investor's liking, provides for each investor to receive some return for its investment and, if the investors are prepared to hold these investments to maturity, potentially receive 100 cents on the dollar.

In the United States, a mechanism does not exist with the same kind of flexibility as the CCAA. There, the equivalent crisis has occurred in the auction rate note marketplace. Many class action suits and investigations are now underway, but it is very unlikely that any investor will receive anything like 100 cents on the dollar after legal fees. There has been criticism lately of the judicial activism apparent in the decisions rendered by Ontario courts in sanctioning and upholding the Plan. Some aspects of those orders are now before the Supreme Court of Canada. However, the results for all parties (other than class action litigators) are arguably much better under the Canadian system.

So what do we learn from all of this? A very clever lady of my acquaintance referred me to a poem by Kipling called Copy Book Headings. The point of the poem is that old sayings become old for a reason: they have proven true in many many cases. In this case, the appropriate saying might be, to paraphrase Warren Buffet, "Never invest in something you cannot understand." It seems unlikely that very many people understood the assets underlying the ABCP they purchased. Perhaps if they had followed Mr. Buffet's advice they would be happier (and richer) today.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.