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What is asset-backed commercial paper? (ABCP)?

Asset-Backed Commercial Paper (ABCP) is a short-term debt instrument that is backed by a pool of underlying assets, typically financial assets such as loans, receivables, mortgages, or credit card debt. ABCP is issued by special purpose vehicles (SPVs) or conduits, which are separate entities created to hold and manage the underlying assets.

Here are key points to understand about Asset-Backed Commercial Paper:

1. Structure: ABCP programs involve the creation of an SPV or conduit that purchases a pool of financial assets from the originating institution (such as a bank or finance company). The conduit then issues short-term commercial paper, which is typically issued at a discount and matures within a range of 1 to 270 days.

2. Collateralized by Assets: The commercial paper issued in an ABCP program is backed by the cash flows generated by the underlying assets. The income generated from the assets, such as loan repayments or interest payments, provides the source of repayment for the commercial paper.

3. Enhancements and Credit Support: To enhance the credit quality of ABCP and reduce investor risk, various credit enhancements are often employed. These can include overcollateralization (holding assets with a value higher than the amount of commercial paper issued), letters of credit, guarantees, liquidity facilities, and credit derivatives.

4. Investor Base: ABCP is typically purchased by institutional investors, including money market funds, hedge funds, and other entities seeking short-term, highly liquid investments. The low-risk perception associated with high-quality ABCP has made it an attractive investment option for those seeking short-term yield with relatively low default risk.

5. Liquidity and Roll-Over Risk: ABCP programs rely on continuous rollover of maturing commercial paper to fund ongoing operations. If there is a disruption in the short-term funding market or if investor confidence wanes, it can lead to difficulties in refinancing maturing commercial paper and pose liquidity risks to the issuing entity.

ABCP played a significant role in the global financial crisis of 2007-2008, as several conduits faced liquidity problems due to exposure to subprime mortgages and a loss of investor confidence. This highlighted the potential risks associated with the asset-backed commercial paper market and led to increased scrutiny and regulatory reforms in the ABCP market.

Investors interested in ABCP should carefully assess the credit quality, structure, and underlying assets of the program, as well as the credit enhancements and risk management practices in place. Understanding the nature of the underlying assets and the creditworthiness of the issuing entity is essential when considering investments in ABCP.