Treasury Today Country Profiles in association with Citi

Buyer beware: does collateralised commercial paper have a future?

Who’s afraid of structured finance? A new institutional cash investment structure has recently come out – one that analysts say has a promising future.

What is it and how does it work?

Called collateralised commercial paper (CCP or collateralised CP), the funding instrument is an asset-backed security that allows long-term assets to be funded with short-term obligations, where the CP is backed by a repurchase agreement (repo).

Diagram 1: Collateralised commercial paper (CCP)

Source: FSOC

As illustrated in the diagram above, and according to the Financial Oversight Stability Council (FOSC), “The bank sets up a special purpose vehicle (SPV) to face the bank on repo transactions. The SPV funds itself with proceeds from CP issuance to cash investors, using the proceeds to enter into traditional repo agreements rather than to buy term assets, as an asset-backed commercial paper (ABCP) conduit would.”

Why is it being introduced?

The introduction of CCP – no to be confused with CCPs (central counterparties) – is thought to represent innovation in response to growing regulatory pressures, in particular in the money fund space. CCP is designed to allow financial institutions to comply with new regulatory guidelines, whilst meeting their business objectives.

“Prudential regulators are setting standards that will require banks and financial institutions to extend the maturity of their liabilities, while the SEC is requiring MMFs to shorten the term of the assets they hold,” says the FOSC’s Annual Report for 2011. “These new requirements have led to the introduction of collateralised commercial paper, which meets the liquidity requirements for investments by MMFs and satisfies the need for financial institutions to extend funding beyond one month to meet the new stressed funding ratio requirements. Collateralised CP is intended to expand funding sources for a variety of debt and equity securities currently funded via tri-party repo.”

Moreover, Lance Pan, Director of Investment Research & Strategy, Capital Advisors Group, identifies four possible drivers for the introduction of CCP, namely:

  • Credit enhancement

  • Maturity arbitrage

  • Capital arbitrage

  • Reduced funding costs

On the fourth point, however, Pan notes: “The thinking goes that after investors grow more comfortable with the new structure, CCP should allow issuers to pay less because of the issuer’s direct obligation and the additional collateral. We are sceptical of the merit of this consideration, since asset backed commercial paper programmes with 100% parental support almost never achieved lower cost of funds than their parents’ unsecured debt.”

Who’s structuring it and who’s investing in it?

Barclays Bank was the first to come to market with CCP, with a $10 billion programme in November 2010; Moody’s gave it the highest short-term rating possible. “Ratings of the structures are pegged to the rating of the sponsoring bank and do not receive a ‘ratings uplift’ above the bank’s rating based on support from potentially illiquid, difficult-to-price collateral or other structural features,” says the FOSC. The rumour mill suggests that numerous other Wall Street institutions are considering branching out into CCP.

As for who is investing, “It appears that large prime money market funds are the main investors in this new CCP,” says Pan. He adds that, “It is conceivable that, over time, other cash vehicles and separately managed accounts may invest in this new-fangled money market instrument.”

Why should treasurers be interested?

With money market funds still a popular short-term investment vehicle for treasurers, and interest in separately managed accounts growing, knowing what CCP is may have its advantages for the future. Pan concludes that, “Investors should carefully evaluate any and all new asset types according to their objectives of safety, liquidity and yield in their separately managed portfolios or in the money market funds they own.”

For those who want to do some further digging into CCP, areas for research could include issuer credit as well as legal and operational considerations, such as legal protection.

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