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Multi-Seller Commercial Paper
Conduits and Securitization
A Brief History and Current Challenges
by Malcolm S. Dorris and Anna E. Panayotou
Published in The Journal of Structured and Project Finance (Winter 2004),
a publication of Institutional Investor, Inc.
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Copyright 2004 Dechert LLP. All rights reserved. Materials have been abridged from laws, court decisions and administrative rulings and should not be considered
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Multi-Seller Commercial Paper Conduits
and Securitization
A Brief History and Current Challenges
by Malcolm S. Dorris and Anna E. Panayotou
In their article entitled “A Primer on Securitization” in the
Summer 2003 issue of this Journal (Volume 9, Number
2), W. Alexander Roever and Frank J. Fabozzi set out an
excellent summary of the basics of securitization, which
entails the pooling and repackaging of the cash flows of
financial assets into securities that are sold in the capital
markets. Securitization performs a crucial economic role
by providing liquidity to most major economic sectors,
including the residential and commercial mortgage
industries, the automobile industry, the consumer credit
industry, the leasing industry, the bank commercial loan
market and the corporate bond market. Through
securitization, most credit risk is transferred from the
originator of the asset to the performance of an asset pool.
In this article, we explore the use in securitization of
multi-seller commercial paper conduits ( “multi-seller CP
conduits”) in greater detail.1
conduit is contained in the Exhibit. Most multi-seller CP
conduits are sponsored and administered by large
commercial banks and the sellers are, more often than not,
existing customers of such banks. The bank sponsors do
not own equity interests in such conduits. They organize
and administer them to offer an alternative source of
funding to customers owning financial assets with
historically-measurable cash flows (such as trade
receivables).
A multi-seller CP conduit offers a bank’s customers a
variety of advantages not available through conventional
financing or other forms of asset securitization. Funding
through commercial paper is frequently the lowest cost
funding available to the customer. It may be the only
alternative to conventional bank financing if the customer
or the assets lack the attributes necessary for access to the
public or private capital markets. A multi-seller CP
conduit offers confidentiality, since the identity of the
sellers in the conduit need not be disclosed to the
commercial paper investors. Multi-seller CP conduits also
offer structuring flexibility and access to a variable
principal amount through revolving facilities.
A multi-seller CP conduit is a special-purpose entity that
regularly buys interests in pools of financial assets from
one or more sellers and funds such purchases by selling
commercial paper notes primarily to institutional
investors. A structural overview of a multi-seller CP
Exhibit
Multi-Seller Commercial Paper Conduit Structural Overview
Obligors
Obligors
Obligors
Seller No.1
Seller No. 2
Seller No. 3
Special Purpose
Entity
Special Purpose
Entity
Special Purpose
Entity
Pool Specific Credit
Enhancement
Programwide Credit
Enhancement
Pool Specific Credit
Enhancement
Conduit
Commercial
Paper Investors
Pool Specific Credit
Enhancement
Programwide
Liquidity
Support
Multi-Seller Commercial Paper Conduits and Securitization - A Brief History and Current Challenges
Negotiations may be easier for the customer than in the
case of private placements or public offerings. In
addition, rating agency review may be more limited.
The use of asset-backed commercial paper conduits began
in 1985. Since then it has burgeoned into a major
financing tool. At the end of 2002, $715 billion in assetbacked commercial paper notes was outstanding. Assetbacked commercial paper outstanding at June 30, 2003
dropped to $683 billion, reflecting, among other matters,
the impact of new regulatory and accounting rules
discussed below.
Asset-backed commercial paper notes are short-term debt
obligations of the conduit with maturities of no more than
270 days and typically much shorter. Purchasers of such
notes are primarily large institutional investors such as
insurance companies and money market funds. Such notes
are attractive investments for money market funds
because they may not invest in obligations which mature
in more than 397 days. Commercial paper notes are sold
through commercial paper dealers that enter into
placement agreements with the conduit. The commercial
paper notes are not registered under the Securities Act of
1933, as amended (the “Act”), and are sold in reliance
upon various exceptions under the Act, including the
“private placement” exception provided by Section 4(2).
In order to preserve that exemption, resale and transfer of
the commercial paper notes by investors is limited. In
addition, multi-seller CP conduits are exempt from
regulation under the Investment Company Act of 1940, as
amended (the “40 Act”).2 Commercial paper notes are
fixed-rate notes usually sold at a discount to their face
amount. The short-term nature of commercial paper notes
means that the cost of funding through such notes is more
similar to floating-rate debt than to fixed-rate debt.
When commercial banks first established multi-seller CP
conduits, they were used primarily to fund pools of trade
receivables. Since then, the asset pool composition of
such conduits has become much more diverse. Although
trade receivables continue to account for roughly 15% of
all assets in multi-seller CP conduits, other asset types
now include credit card receivables, auto loans, auto
leases, equipment loans, equipment leases, aircraft and
engine leases, student loans, consumer loans, commercial
loans, home equity loans, residential mortgage loans, film
receivables, floorplan-financed assets, insurance
premiums, future flows and a variety of other asset types.
Multi-seller CP conduit transactions in the United States
have a two-step sale structure3: First, the seller transfers
assets in a legal true sale to a wholly-owned special
purpose subsidiary of the seller (“SPE”). This step
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requires opinions of counsel as to “true sale” and “nonconsolidation.” Through this step, the seller may obtain
off-balance-sheet treatment and the conduit’s exposure to
the risk of the bankruptcy of the seller is made more
remote. Then, in the second step, the SPE subsequently
sells an undivided percentage interest in the assets to the
conduit. By increasing and decreasing the percentage
amount of the conduit’s undivided interest in the assets, a
multi-seller CP conduit is able to provide a seller with the
equivalent of a revolving facility through which newly
created assets may be purchased over an agreed-upon
period of time (subject to various events that would
trigger the end of the revolving feature). This feature is
useful particularly to companies with seasonal businesses.
In contrast, the longer-term securitization market offers
such companies less flexibility.
Credit Enhancement
Multi-seller CP conduit transactions have two types of
credit enhancement: pool-specific, which is built into the
structure of each transaction, and program-wide, which is
built into the structure of the conduit.
Pool-specific credit enhancement provides protection
against credit losses (the inability of the obligors of the
receivables to make payment), dilution (reductions in
amounts payable due to returns, offsets, disputes or any
other claims that the obligors may have against the seller),
and yield risk (the rate of interest payable on the assets
not matching the rate of interest payable on the conduit’s
commercial paper notes). Pool-specific credit
enhancement covers risks arising from a particular seller’s
assets and is not available to cover losses on the assets of
other sellers in the same multi-seller CP conduit. Poolspecific credit enhancement often takes the form of
overcollateralization (the value of the assets exceeds the
principal amount of funding made available to the seller),
excess spread (the rate of interest paid on the assets
exceeds the rate of interest paid on the commercial paper
notes) which is captured in a reserve account, and/or the
funding of a reserve account at closing using a portion of
the initial proceeds from the sale of the assets. The
amount and form of pool-specific enhancement is
determined based on historical losses and dilutions, and
servicing risk (how difficult it would be to replace the
servicer) among other factors. Increasingly, pool-specific
credit enhancement is dynamic, rather than simply a fixed
percentage of the asset pool. For example, if the
performance of an asset pool deteriorates below
expectations, the transaction documents will call for an
increase in the required reserve amount. Pool-specific
credit enhancement is structured to meet the credit quality
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Multi-Seller Commercial Paper Conduits and Securitization - A Brief History and Current Challenges
levels set by the rating agencies in order to maintain the
rating of the conduit’s commercial paper notes.
Program-wide credit enhancement is built into the
structure of the multi-seller CP conduit. The
organizational documents of the conduit set forth the
required facilities. Such facilities are constructed so they
will be available to be drawn to cover losses on any
transaction in the conduit. Thus, if total collections are
insufficient to make payments on the conduit’s maturing
commercial paper due to deteriorating asset quality, such
payments may be made from the program-wide credit
enhancement facility. The rating of any provider of such
program-wide credit enhancement, which may be the
conduit’s bank sponsor or a third party, must be at least
equal to the rating of the conduit’s commercial paper
notes. Forms of program-wide credit enhancement
include letters of credit, committed loan or purchase
facilities, cash collateral invested in enumerated approved
investments or an insurance policy from a highly-rated
monoline insurer. The amount of program enhancement
required for a multi-seller CP conduit is determined by
the rating agencies and depends on historic portfolio
performance and seller concentrations, among other
factors. The cost of program-wide credit enhancement is
passed on to the sellers.
Multi-seller CP conduits are classified as either “fullysupported” or “partially-supported,” depending on the
amount of credit enhancement available to such conduit.
If the conduit’s credit enhancement is enough to cover all
credit risk, the conduit is said to be “fully supported.” In
such cases rating agencies base the rating of the conduit’s
commercial paper notes on an analysis of the conduit’s
program documentation and on the ratings of the creditsupport providers, rather than on the quality of the asset
pools. This allows for easier and quicker closing of
transactions, but such conduits have higher costs. In
contrast, the rating agencies may conduct more due
diligence and credit analysis of sellers and asset pools in
transactions involving a multi-seller CP conduit that is
“partially-supported.” Whether a rating agency will
require such review depends on many factors, including
the track record of the multi-seller CP conduit and the
experience and sophistication of its sponsor. Rating
agencies may require transactions in partially-supported
conduits to be reviewed either pre-closing or post-closing,
depending on their assessment of the multi-seller CP
conduit, the seller and the assets. Some “pre-closing
review” multi-seller CP conduits are able to place
transactions into their programs without prior review by
the rating agencies by increasing the program-wide credit
enhancement facility by the amount of commercial paper
sold to fund the transaction. This feature permits multi-
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seller CP conduits to enter into transactions that must
close quickly.
Liquidity Facilities
In addition to credit support, rating agencies also require
that each multi-seller CP conduit have liquidity facilities.
Unlike credit enhancement, which protects a multi-seller
CP conduit from asset defaults and dilution, liquidity
facilities make funds available to the conduit when factors
other than credit deterioration result in a cash flow
shortfall such that commercial paper investors would not
receive timely repayment on maturing commercial paper
notes. Such factors include a disruption in the
commercial paper markets that prevents a conduit from
“rolling” maturing commercial paper and timing
mismatches between maturing commercial paper notes
and cash collections on asset pools. Liquidity facilities
may take the form of either a loan agreement pursuant to
which loans are made to the conduit secured by the asset
pools in the conduit, or an asset purchase agreement,
pursuant to which the liquidity provider purchases nondefaulted assets from the conduit. In practice, the
liquidity facilities of some conduits also have been
available to fund the purchase of new receivables when
no termination event has existed. New regulatory
constraints discussed below may make it more difficult
for such facilities to serve any function other than “pure”
liquidity.
As with credit enhancement facilities, liquidity facilities
may be either program-wide or pool-specific. A programwide liquidity facility may be drawn on to support all of
the commercial paper notes issued by a multi-seller CP
conduit, whereas pool-specific liquidity may be drawn
upon only with respect to the commercial paper notes
issued to fund the particular transaction to which such
notes relate. Historically, the cost of liquidity facilities
has been affected by seller-specific and more general
factors. With respect to each asset pool, a liquidity
provider will examine the credit rating and business of the
seller, and the credit quality and term of the assets in
order to gauge the risk that the facility will be drawn.
More generally, ratings downgrades of bank liquidity
providers, consolidation in the banking sector and
proposals by the Bank for International Settlements
(“BIS”) affecting regulatory capital requirements have
made liquidity scarcer and more expensive.
The industry has responded by developing alternative
forms of liquidity, including “liquidity notes” or
“extendible notes.” Liquidity notes are issued by an SPE
that is separate and apart from the multi-seller CP conduit.
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Multi-Seller Commercial Paper Conduits and Securitization - A Brief History and Current Challenges
It is managed by the multi-seller CP conduit’s sponsor.
The “liquidity SPE” enters into an agreement with the
multi-seller CP conduit pursuant to which it commits to
purchase pools of assets. The liquidity SPE sells its
liquidity notes to institutional investors in the amount of
this commitment, thus tapping the capital markets for
funding as opposed to commercial banks or insurers. The
liquidity SPE uses the proceeds of the sale of its liquidity
notes to purchase the commercial paper notes of the
multi-seller CP conduit. Like commercial paper notes,
liquidity notes are issued for short maturities (one to 90
days) at a discount to their face amount. Unlike
commercial paper notes, if liquidity notes cannot be
“rolled” at maturity, the liquidity SPE may extend the
maturity date of such notes for a period of up to 390 days
from their date of issuance. After extension, the liquidity
notes carry a higher rate of interest paid monthly until
maturity. If called upon to purchase asset pools from the
multi-seller CP conduit, the liquidity SPE pays for such
asset pools by using its holdings of the multi-seller CP
conduit’s commercial paper. The result is that the
aggregate outstanding principal amount of the multi-seller
CP conduit’s commercial paper notes is reduced.
Accounting Issues
Recent accounting changes and additional proposed
accounting and regulatory changes have created
considerable uncertainty for multi-seller CP conduits.
This uncertainty has slowed growth and in some cases
increased pricing.
rewards of the SPE, then the entity required to consolidate
the SPE is not the entity having the majority of the voting
control but the entity that bears the majority of the
variability of the risks (or is entitled to the majority of the
rewards to the extent no one party bears the majority of
the variability of the risk). Under these rules, the
commercial bank sponsor of a multi-seller CP conduit
would be required to consolidate the assets and liabilities
of the conduit, even though it owns no equity in the
conduit. After a comment period in which various
concerns were expressed, FASB clarified and modified
Initial FIN 46 in a revised version dated October 31, 2003
entitled “Proposed Interpretation of Consolidation of
Variable Interest Entities, a modification of FASB
Interpretation No. 46” (“Revised FIN 46”). Revised FIN
46 clarified certain provisions and included certain
limited-scope exceptions to its application.4
Consolidation of the assets and the liabilities of a multiseller CP conduit on the sponsor’s financial statements
could have a negative impact on various financial ratios
and covenants required to be maintained by such banks
and on the ability of bank holding companies to raise
capital. Additionally, consolidation would require bank
sponsors to maintain increased regulatory capital.
Sponsors have reacted in a variety of ways including:
n
n
n
Previous accounting rules did not require the commercial
bank sponsor of a multi-seller CP conduit to consolidate
the assets and liabilities of such conduit -- even though
the sponsor had many operational, administrative and
economic interests in the conduit (e.g., referral agent,
administrator, liquidity provider and credit support
provider)--as long as the sponsor did not have voting
control of such conduit. In January 2003, the Financial
Accounting Standards Board (“FASB”), the
representative body of independent public accountants
that promulgates generally accepted accounting principals
in the United States, released an exposure draft of
Interpretation Number 46, Consolidation of Variable
Interest Entities (“Initial FIN 46”). (See “Is My SPE a
VIE Under FIN 46 and, If So, So What? by J. Paul
Forrester and Benjamin S. Neuhausen, Journal of
Structured and Project Finance, Fall 2003.) The basic
concept underlying Initial FIN 46 was that if the equity in
an SPE is insufficient to enable it to stand on its own
without additional support and the equity investors do not
participate in decisions affecting the economic risks and
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n
n
increasing conduit charges to compensate for
higher costs,
reducing the size of conduits,
limiting transactions in conduits to the sponsor’s
own customers and to transactions that move
assets (such as mortgages loans, commercial
loans and credit card receivables) off the bank’s
own balance sheet,
requiring the assets to be more highly rated or
wrapped by a financial guarantor, and
selling the “expected loss” piece to third parties
willing to consolidate the assets and liabilities of
the conduit in exchange for anticipated high rates
of return.
With respect to the sale of the “expected loss” piece, such
transactions most often have taken the form of the sale of
subordinated debt (which is treated like equity) to private
equity firms through privately placed transactions exempt
from the Act. If these accounting changes result in higher
costs to users of multi-seller CP conduits, sellers may
choose to use the longer-term, asset-backed market, to the
extent that they qualify for such a market.
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Multi-Seller Commercial Paper Conduits and Securitization - A Brief History and Current Challenges
Some conduit sponsors reacted to the probability that
Initial FIN 46 would force them to consolidated multiseller CP conduits by attempting to assure that such
conduits would be recognized by accountants as
“qualified special purpose entities” (“QSPEs”) under
FASB’s Financial Accounting Standard 140 (“FASB
140”), since a QSPE will be exempt from the revised
consolidation rules. To qualify conduits as QSPEs, some
bank sponsors imposed strict limits on such conduits’
activities. To take one example, one bank eliminated the
ability of its conduits to draw on its liquidity facility to
fund new purchases of assets, limiting the use of the
facility exclusively to refunding maturing commercial
paper during market disruptions. Efforts to remake
conduits into QSPEs were further complicated by
proposed amendments to FASB 140 released in June 2003
(see discussion below).
FASB has postponed the effective date for application of
the consolidation rules of Revised FIN 46 for all “variable
interests” acquired before February 1, 2003 until the end
of the first accounting period ending after December 15,
2003 (i.e. December 31, 2003 for calendar year end
companies) thus providing additional time for bank
sponsors to make adjustments in their multi-seller CP
conduit programs.
For the moment, foreign commercial banks that sponsor
multi-seller CP conduits are not affected by these changes
in United States accounting rules. As a result, they may
have an advantage over U.S. commercial bank sponsors
since they may be able to offer lower costs.
On June 10, 2003, FASB issued its exposure draft
entitled Proposed Statement of Financial Accounting
Standards: Qualifying Special Purpose Entities and
Isolation of Transferred Assets, an amendment of FASB
Statement No. 140 (the “140 Exposure Draft”). The
stated goal of the 140 Exposure Draft was to remove the
incentive to convert certain entities to QSPEs to avoid
consolidation.5 The 140 Exposure Draft changes
requirements for being a QSPE in several ways. For
example, the entity may not enter into an agreement with
the transferor pursuant to which the transferor is
committed to “deliver additional cash or other assets to
the SPE or its beneficial interest holders [its investors].”6
One possibly inadvertent result of this proposal is that it
may prohibit the transferor in a typical two-step conduit
transaction from agreeing to standard transferor
indemnities and repurchase obligations for breaches of
representations and warranties and for dilution. Other
proposed amendments which might impact multi-seller
CP conduit transactions include:
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1.
limiting the ability of transferors to make
decisions about the reissuance of beneficial
interests, which might be deemed to apply to the
daily fluctuation of the conduit’s undivided
interest in the pool of receivables, 7
2.
prohibiting a QSPE from holding derivative
instruments entered into with the transferor,8 and
3.
requiring the second SPE in a two-step
transaction to be a QSPE which would require an
additional QSPE to be interposed between the
QSPE subsidiary of the seller and the non-QSPE
conduit9.
In their comments to FASB on the 140 Exposure Draft,
multi-seller CP conduit professionals have urged FASB to
clarify these matters.
Regulatory Capital Issues
Another challenge to the continued viability of multiseller CP conduits stems from proposed changes to the
regulatory capital that banks are required to maintain
against the assets they hold. In 1975, the supervisory
authorities and central banks of major developed
countries established the Basel Committee on Banking
Supervision at the Bank for International Settlements in
Basel, Switzerland (the “Basel Committee”). In 1988, the
Basel Committee issued capital adequacy guidelines
which then were adopted by the major industrialized
nations (“Basel I”). Beginning in June 1999, the Basel
Committee has pursued the goal of achieving a consensus
on a revised accord (“Basel II”). The Basel Committee
issued its Third Consultative Paper on Basel II on April
29, 2003. The goal of the Basel Committee is to complete
Basel II by mid-2004 with implementation to take effect
in member countries by the end of 2006. On August 4,
2003, the four relevant regulatory agencies in the United
States issued an Advance Notice of Proposed Rulemaking
which constitutes the agencies’ plan to implement Basel II
in the United States (the “U.S. Proposal”).
After the release of the Basel II proposal, securitization
professionals were critical of the capital treatment that it
accorded to securitizations. After reviewing comments,
the Basel Committee issued a press release on October 11,
2003 indicating that it planned on “simplifying the
treatment of asset securitization, including the elimination
of the ‘Supervisory Formula’ and replacing it by a less
complex formula.”10 Despite this announcement, U.S.
securitization professionals continue to express concerns
about the perceived impact of Basel II and the U.S.
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Multi-Seller Commercial Paper Conduits and Securitization - A Brief History and Current Challenges
Proposal. In its letter dated November 3, 2003 (the
“Comment Letter”), to the Board of Governors of the
Federal Reserve System, the Office of the Comptroller of
the Currency, the Federal Deposit Insurance Corporation,
and the Office of Thrift Supervision, the American
Securitization Forum summarized its concerns with
respect to asset-backed commercial paper by saying that
“the current proposal does not present a workable internal
approach for the calculation of capital for ABCP conduit
facilities and the resulting capital requirements
significantly overstate the risks of these facilities.”11 It
pointed out that, under the U.S. Proposal, in order to
apply Basel II, banks would be required to have liquidity
and credit enhancement facilities externally rated, “which
would be time-consuming and add costs for each
transaction while providing relatively little benefit given
the relatively low risk of a liquidity facility, infrequency
of draws and very low losses under these facilities
historically.”12 Instead, it urged the use of the bank’s own
internal ratings and systems to gauge risk, subject to the
approval of the bank’s regulator.13 Working groups of the
Basel Committee are currently working on the
“simplifications” noted in its Press Release of October 11,
2003. It remains to be seen whether further changes will
be made to Basel II and how it will be incorporated into
U.S. law.
7
140 Exposure Draft p. 2, proposed addition of new
paragraph 35(f)
8
140 Exposure Draft p. 2, proposed amendment to
paragraph 35(c)(2)
9
140 Exposure Draft p. 3 proposed amendment to
paragraph 83
10
Bank for International Settlements, “Basel II:
Significant Progress on Major Issues”, 11 October,
2003.
11
Comment Letter, p.2
12
Comment Letter, p.10
13
Comment Letter p.2
14
Comment Letter, p. 2
The accounting and regulatory issues posed by Revised
FIN 46, proposed amendments to FASB 140 and Basel II
are the most significant challenges to face multi-seller CP
conduits during their 18-year history. As the Comment
Letter notes, the ultimate implementation of Basel II will
affect whether securitization will continue to play the
liquidity and risk dispersion roles that it has effectively
performed for nearly two decades. 14
Endnotes
1
This article does not examine securities arbitrage
conduits established to take advantage of arbitrage
opportunities in the fixed securities markets.
2
See Rule 3a-7 under Section 3(a) and Section 3(c)(5)
of the 40 Act.
3
Outside the United States, one-step transactions are
common due to differences in the bankruptcy laws.
4
Revised FIN 46, p. ii. The comment period on for
Revised FIN 46 expired on December 1, 2003.
5
140 Exposure Draft p. ii
6
140 Exposure Draft p. 2
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