Asset-backed commercial paper - What is asset-backed commercial paper?
Asset-backed commercial paper (ABCP) is a type of conduit financing. It’s a short-term investment vehicle commonly used by large corporations or financial institutions to raise capital to pay for their short-term liabilities. The maturity on ABCP is commonly between 90 and 270 days.
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Companies with good credit ratings can sell ABCP to investors. This type of commercial paper offers more security to investors as it is backed by the company’s physical assets, for example, trade receivables.
How does Asset-backed commercial paper work?
An asset-backed commercial paper is a type of collateralized debt obligation that is sold on the secondary market. The company selling the ABCP must set up a special purpose vehicle (SPV) which owns the asset. This conduit is a separate entity to the organisation and has its own assets and liabilities.
The conduit is not bound to the sponsoring company’s balance sheet. By using the SPV, the company can hold the asset ‘off-balance sheet’. The ABCP is then issued by the SPV.
Creating a SPV and issuing ABCP via the SPV isolates the financial risk associated with asset-backed commercial paper. As the SPV is a separate legal entity it protects the asset against the company going bankrupt: even if the company goes bankrupt, the SPV can carry on.
The structure of asset-backed commercial paper
Asset-backed commercial paper can be issued by both single-seller programmes and multi-seller programmes.
Single-seller conduits buy receivables from only one seller. Therefore, they usually have only one collateral type.
When engaging with multi-seller conduits, the asset-backed securities that are purchased to be used in the ABCP are bought from more than one seller. Multi-seller conduits may therefore be less risky as there is more diversification. When engaging in multi-seller programmes, there is often credit enhancement that helps to mitigate possible credit and liquidity risks.
A sponsor or third-party bank can act as a credit enhancement provider by offering cash reserves or guarantees to minimise the credit risk. Liquidity risk is also a concern with ABCP.
Placement agents are responsible for providing the conduit access to investors. They provide the instruction of issuance and sell the ABCP to investors. This process is checked by qualified investors. ABCP issuance programmes normally include at least two placement agents, who are usually investment banks.
Investors buy the ABCP via the conduit, which then replays the investors through the placement agents. Repayments to the ABCP investors are then collected from principals or interests from the underlying receivables.
The difference between commercial paper and asset-backed commercial paper
The fundamental difference between commercial paper and asset-backed commercial paper is that the former is not backed up by financial assets. Commercial paper only acts as a promissory note that is backed up by the issuing company’s high credit rating. ABCP is also issued by companies that have a high credit rating but also have additional asset-backed securities.
Advantages of asset-backed commercial paper
It is possible for sellers to adjust the amount of asset-backed commercial paper they sell in response to their changing financial needs. Terms of financing can also be revised through ABCP conduits.
Just like commercial paper, ABCP is a short-term debt instrument. Therefore, ABCP comes with a lower credit risk than long-term corporate bonds.
ABCP is backed by securities. This makes them safer than traditional commercial paper which is unsecured. Even though commercial paper can only be issued by corporations that have excellent credit ratings, they are still unsecured and therefore carry financial risk. ABCP is therefore safer as they too are characterised by excellent credit ratings and are furthermore backed by receivables.
