DBRS’s Andrew Fitzpatrick has a wonderfully understated way of putting things:
. . . it would be something between ironic and sad if the best-laid plans of the Montréal Accord, a difficult but ultimately successful private-sector restructuring in response to the financial crisis, that was a year-and-a-half in the making, were to be undone by a foreign government’s response to that same crisis. It is a small world after all.
This is DBRS, the Canadian rating agency, talking about the Dodd-Frank bill.
And not in terms of the ratings accountability kerfuffle either.
It seems there’s some concern that the restructured vehicles of Canada’s Asset-Backed Commercial Paper (ABCP) conduits, might be impacted by recently-passed US regulatory reform.
The country’s ABCP market essentially froze up in August 2007. Major ABCP investors ended up convening in Montreal and agreeing to one of the largest structured finance restructurings in history. The products of the year-and-a-half process are the Master Asset Vehicles.
And regulatory reform just might be heading their way. As DBRS puts it:
. . . although it is unlikely that the politicians and officials who drafted the Act are familiar with the Montréal Accord or Master Asset Vehicle I and Master AssetVehicle II (collectively, the MAVs), the Act could have adverse consequence for the MAVs . . .
In the aftermath of the financial crisis, both derivative products and collateralized debt obligations (CDOs) were often cited among the usual suspects said to have contributed to the systemic risk that led to the crisis. One of the objectives of the Act is to bring more scrutiny, transparency and regulation to the trade of derivative products. Since approximately 70% of the asset interests held by each of the MAVs consist of derivative products, the MAVs could fall under the new regulatory requirements of the Act.
As DBRS notes, this is all rather speculative, since many of the Dodd-Frank derivatives details have yet to be formulated or finalised by the SEC and the US Commodity Futures Trading Commission.
Nevertheless, DBRS sees some potential for possible impact:
Despite the fact that the Act is U.S. legislation and the MAVs are trusts under Ontario law, the MAVs maynevertheless fall within the scope of the Act, as many of the MAV’s swap counterparties are U.S. entities. Itis also not clear if all of the provisions of the Act will apply to existing transactions. If not, or if an exception for existing transactions is available, it is possible that the MAVs might not fall within all of the provisionsof the Act.
In the event that the MAVs fall under the Act, they could be defined as “major swap participants” or “major security-based swap participants.” If this is the case, the MAVs could face capital requirements, collateral requirements and reporting and registration requirements. All would entail costs – significant costs in the case of capital and margin requirements. Since the MAVs have little or no ability to raise additional funds, they may not be able meet these obligations.
Should one of the MAVs be unable to meet its new regulatory-induced obligations, DBRS frets, they might face fines or exclusion from future swap transactions, or who knows what.
In a worst case scenario, according to DBRS, the swaps themselves could be terminated which would then force them to be valued at market prices. Given the sheer size of the MAVs (about C$32bn) those prices would likely be depressed, leading to degrees of realised or even complete losses, DBRS says.
Again though — that’s a worst case scenario. As DBRS puts it:
Much of the above remains uncertain, given the lack of clarity in the Act and the pivotal role of the yet-to-unfold rule-making process. It should be emphasized that the unwinding of the MAV structures should be considered a worst-case scenario. Nevertheless, in light of the potential risks, DBRS believes investors should be aware of these possibilities.
Related links:
Canadian ABCP saga lives on - FT Alphaville
Derivatives legislation under Dodd-Frank - Lexology
Restructuring for ABCP market - FT