Asset-Backed Commercial Paper (ABCP) has been an important funding source for banks for many years. However, since the Global Financial Crisis (GFC) in 2007-2008, the Private ABS market has experienced a decline. Despite this, the sector is still alive and has the potential to grow and evolve.
In this article, we will summarize the main insights from the ABCP and Private ABS markets panel that took place at the 2023 Global ABS conference.
During the panel, which featured our CEO & Co-Founder Altin Kadareja, Eugene van Esveld, and Mark Escott, the speakers discussed the current state of the ABCP and private ABS markets, the role of SRT transactions and their impact on the market, the factors that influence banks’ decisions to fund using ABCP conduits, and the future of the overall market, including how technology (and particularly AI) can enable better and faster decisions.
Navigating Uncertainty with ABCP: How Short-Term Investment Structures Provide Resilience and Stability in Volatile Markets
ABCP is a short-term investment structure backed by assets, typically trade receivables, with a maturity between 90 and 270 days. Over time the performance of conduits and underlying assets has been positive, with transaction structures proving resilient across economic cycles, confirming the role of ABCP as an alternative funding source for banks, particularly when the public market is volatile.
The short-term investment structure of ABCP is appealing, especially in uncertain macroeconomic conditions. While challenges may arise due to higher interest rates and potential defaults, the quality of credit and resilience of the asset class are encouraging.
Overall, ABCP is well-positioned to weather challenges and offers flexibility and structure that meet investor and market needs.
A Closer Look at the Post-GFC Landscape and Current Trends
The market has experienced a decline since the Global Financial Crisis (GFC) in 2007-2008 where it reached the peak at $1.2 trillion in US and $157bn in Europe. A large part of that was comprised of hybrid credit arbitrage and structured investment vehicle conduits that are no longer part of the market.
Now we are at approximately $296billions in the US market, and $61 billion in Europe. The market is still alive, albeit smaller than before, and growing (16% increase in outstanding amount in the last year for the US market).
Looking at the composition of the market, we can note the prevalence of multi-seller conduits and the absence of certain types of vehicles that used to be part of the market. Especially in the US market, multi-seller conduits dominate the market, primarily financing trade receivables, auto loans, consumer loans, and equipment assets. In terms of main investors in the market, money market funds and asset managers are the major participants. Europe follows a similar pattern.
Development of the European Private Securitization Market: Trends and Key Findings
Switching to the European private ABS and overall Securitization market, a research carried out by AFME, European Datawarehouse and True Sale International gives us interesting insights into the sector development over the las few years.
Starting from committed amount of banks participating to a market led initiative called European Benchmarking Exercise consistently growing to € 67 billion euros and the assets amount, researches have been able to estimate the overall market size at around 183 billion euros as of June 2022. Over the last 12 months, we see a stable trend in terms of the distribution of asset types.
Trade receivables are the most prevalent, followed by auto loans and leasing, consumer loans, equipment leasing, and so on. Germany is the top seller country, followed by Great Britain, France, and Italy.
Financial and insurance companies are the dominant seller industry, followed by leasing and manufacturing, and electricity and gas.
The quality of transactions is positive, with most of them rated as AA, AAA, and A. Migration from AA to AAA and from A to AAA has slightly improved. There were 31 new commitments and 33 drops in H2 2020 and H1 2022, indicating stable and good quality transactions to fund the economy.
Finally, 56.7% of transactions were STS transactions, with auto loans and leasing being the highest asset type, followed by equipment leasing and trade receivables.
Main factors Driving Banks’ Decision to use ABCP Conduits
What drives banks’ decision to fund in the private market using ABCP conduits versus bank funding from the perspective of a bank sponsor?
One reason is definitely diversification of funding, although not a strong argument today as incremental liquidity is limited by full support that banks give to conduits (though liquidity lines) which pushes investors aggregating bank and conduit exposures.
ABCP allows, nevertheless, to access dedicated investment buckets and create complementary offers to investors in terms of tenors.
What is a really significant benefit is regulatory capital relief, which European banks can obtain from the STS structure: this benefits European conduits for trade receivables when they can take the concentration limit at conduit level rather than transaction level (although not true of all conduits).
Other benefits include the fact that regulatory reporting is generally less onerous in a conduit than for transactions, which makes the process easier, consistency with peers (as a bank your offering is consistent), and internal benefits (cost benefit or liquidity benefits).
In addition, as other private structures, ABCPs offer high flexibility in terms of structuring and privacy (as you don’t need to disclose as many information).
Managing STS Transactions: Navigating Complexity in Data Management and Compliance
STS structures create simple, transparent, and standardized transactions, which can provide comfort to investors and offer capital relief and better returns for banks. However, we need to mention that STS compliance is not a requirement for ABCP investors and that the future of STS in the market is still evolving.
The client is also an actor that ultimately benefits from STS because there’s lower capital charge and in theory more competitive pricing.
From a data management perspective, managing STS (Simple, Transparent, and Standardized) transactions can be complex. The process involves ensuring data availability and quality throughout the lifetime of the transaction. As a multi-seller, multi-asset scenario, data may come from various sources and formats, requiring compliance with set templates and maintaining data quality.
Transparency and compliance are crucial for meeting market expectations. The increasing market interest in transparent data and capital relief is evident from a 33% increase in committed capital in private transactions in the last six months of 2022.
However, managing data security, privacy, and compliance with banking regulations adds further complexity. Implementing appropriate systems and possibly relying on third-party solutions can assist with these challenges.
Additionally, SDS reporting is not a one-time exercise but requires ongoing adherence to policies and practices throughout the transaction’s duration. Overall, while complex, managing STS transactions is feasible with careful attention to data management.
Opportunities and Challenges of Green ABCPs
Two European conduits and one US conduit have issued green Asset-Backed Commercial Paper (ABCP). Cassie Lafayette and LMA issued green ABCP for electric vehicles, while LMA issued green CP for trade receivables contributing to energy and environmental transition. BWS Weinberg also issued green ABCP backed by a pool of e-bikes.
Independent reviews of the green credentials were conducted in both cases, and they followed the ICMA Green Bonds principles. The market is interested in more green ABCP, and there are precedents for such issuances.
However, the critical mass of green assets is not yet sufficient, and it is challenging to separate them from other assets in many conduits. Creating a separate tranche and legal structure for green assets would require a conduit restructure, which introduces complications, for example related to prepayment.
Another concern is the lack of common standards for defining green CP or green ABCP. Disclosure and monitoring of green credentials are areas of worry, particularly in the more litigious US market. The absence of common standards and structural challenges in conduits have hindered significant progress in the green ABCP market. Additionally, there is no pricing benefit or discount associated with issuing green CP at present, although it is considered the right thing to do.
Standardization and streamlined formats for green products are crucial to optimize costs and attract investors. Currently, there is limited investor demand for such products, and making them more attractive to the investor base is necessary.
Data Availability and Infrastructure Challenges for ESG/Green deals
Data availability for ESG or green deals depends on the type of transaction and asset class. There are three categories of data: asset class, stakeholders, and structure, which need to be merged to qualify a deal as ESG or green. Currently, there are around 28 to 29 different standards globally for classifying sustainable and green products, leading to market confusion.
Data specific to certain asset classes, such as electric vehicles and trade receivables, can be beneficial for classifying deals. For example, data extracted from the asset class itself and its collateral can contribute to the classification process. So the data is there, but you need to have the right infrastructure in place to collect the data.
However, the market is still in the early phase, lacking a clear understanding of investor requirements due to regulatory confusion. The EU Taxonomy is definitely playing a good role into that because it is helping to align the interests across all the players.
Blockchain and AI are also emerging trends in ABCP. Rabobank is testing blockchain for daily IPA settlement in regular CP, but challenges remain. AI is already being used as an important tool, particularly in due diligence processes, risk assessment, macroeconomic forecasting, and ESG analysis. However, compliance and implementation challenges exist for large banks and institutions.
Overall, while data for ESG and green deals is available, infrastructure and standardization efforts are needed. AI and blockchain show promise but require further development and overcoming obstacles for broader adoption in the market.
The Role of AI in the market to support critical processes and operations
AI is becoming an important tool in the market. ChatGPT and OpenAI have definitely helped to democratize the logics of AI and have really shown the clear benefit in using it. While for other technologies, blockchain market actors don’t really see the benefit and they consider it an additional cost, on the artificial intelligence side people are understanding more than ever what it can do for businesses.
At Cardo AI for example, we help our clients and market participants through several processes: due diligence (legal contracts, understanding waterfall and structure of the proposal), risk assessment and risk analytics on top of our asset classes (analyzing underlying assets of the pools themselves), scenario simulation (users input macroeconomic indicators to simulate and benchmark against existing scenarios).
Specifically during the due diligence process, we use NLP algorithms to understand how contracts are structured and what are their main elements, and then predict what will happen in the future based on them. How each single element can have a positive or negative impact on the performance of the transaction? How is the waterfall likely to play out? In order to detect fraud, we mostly look at the underlying assets. We analyze every asset and borrower to understand where transactions are coming from, whether their amounts are realistic, if relationships between seller and debtor have changed recently, etc.
Many of our clients are finding it useful to stress test their current portfolios, to actually understand if in the next six months to nine months or one year, they could have a negative outcome of increased defaults or lower returns on their portfolios.
Another useful application of AI, as mentioned before, is ESG. We are extracting a lot of data from different alternative data sources (websites, products and service reviews, third-party data) in order to classify and evaluate single borrowers or assets from an ESG perspective.
Overall, AI has definitely a significant role to play in the market, and we hope to see it applied more and more by financial actors. However, banks and big institutions still face challenges in the application of AI algorithms into their daily operations, mostly because of compliance. Therefore, adoption will be slow.
Assessing the Impact of Disclosure and Reporting Requirements on the Market
The current disclosure and reporting requirements for ABCP are not seen as significant barriers for the market. The necessary reporting to investors and rating agencies was already in place, and additional requirements from regulatory bodies such as the European Securities and Markets Authority (ESMA) and the Bank of England have been implemented.
The data is made available by many market actors monthly on portals for investors, potential investors, and regulators. However, not a lot of regulators actively request or utilize the provided data, which can be frustrating considering the effort put into ensuring transparency. From a customer perspective, the reporting requirements can be seen as a constraint, as some may prefer unsecured loans to avoid the burden of extensive reporting.
Nonetheless, overall transparency and disclosure are considered important for building trust among stakeholders in ABCP transactions. It is acknowledged that the requirements have undergone frequent changes, and while it may not be easy to continually meet them, having a flexible system in place can help adapt to future demands.
Encouraging investors to understand and utilize the available data more effectively could further enhance transparency and trust in the market.
The future of ABCP: is it still an important source of funding?
The future of ABCP (Asset-Backed Commercial Paper) appears positive. It has demonstrated robustness, flexibility, and benefits for clients and banks. Despite macroeconomic developments, the market is growing with new seller programs and increased outstandings.
ABCP provides an alternative funding source, particularly when the public market is volatile. The performance of conduits and underlying assets has been positive, with transaction structures proving resilient across economic cycles. The short-term investment structure of ABCP is appealing, especially in uncertain macroeconomic conditions.
While challenges may arise due to higher interest rates and potential defaults, the quality of credit and resilience of the asset class are encouraging. Overall, ABCP is well-positioned to weather challenges, and offers flexibility and structure that meets investor and market needs.