John Greenwood
Friday, October 17, 2008


TORONTO -- There was so much confusion among Canadian investment dealers about the true nature of asset backed commercial paper that many couldn't say how much of the product they held when the market froze up last year, according to the industry's self-regulatory body.

In a report released on Friday, the Investment Industry Regulatory Organization of Canada said one of the "greatest challenges" it faced when it launched a fact-finding initiative into the market failure was figuring out who was exposed, because some dealers did not distinguish the third-party ABCP that seized up from conventional debt instruments such as plain vanilla commercial paper. In fact, the stalled ABCP was backed by risky credit derivatives, some linked to subprime mortgages.

Further, IIROC said it found "inadequacies" in the dealers' due diligence of the product category.

The report, issued more than a year after the $35-billion market for third-party ABCP fell apart, makes a number of recommendations, mostly focusing on the need for dealers to understand investment products before they sell them.

"Dealer members must have a product due diligence process that takes into account the nature of the product and the target investors," the report says.

Brokers should also ensure that they understand the needs of their clients and that the products they introduce them to are suitable.

Another recommendation is that dealers should ensure greater transparency in products they are involved in.

The lion's share of the frozen ABCP was sold to institutions, however about $372-million ended up in the hands of retail investors, most of who relied on their brokers for advice about the product.

Many firms that sold the notes relied on ratings issued by DBRS, the only rating agency willing to offer an opinion on third party ABCP.

IIROC recommends that brokers should conduct their own assessments of the products they sell.

According to the report, 26 IIROC member firms were involved in the third-party ABCP market, including 13 that sold it to retail clients. Most of them bought the paper back from individuals shortly after the freeze-up in August 2007, but a handful -- including Canaccord Capital Corp. and Credential Securities -- did not. Both have agreed to repurchase the notes they sold following a proposed restructuring of the market.

"What we have tried to do [with this report] is not point fingers or blame people," said IIROC chief executive Susan Wolburgh Jennah, "What's we've tried to do is take a look at a very difficult situation and understand what lessons can be learned... We tried to do what I consider to be the right thing here, which is to look at the issues, to understand what happened and to make constructive recommendations" so this doesn't happen again.

Backers of a proposed restructuring have said they expect the process to be complete by the end of this month.