Asset-backed commercial paper (ABCP) was launched by the National Association of Financial Market Institutional Investors in June 2020 as an innovative financing product derived from traditional asset-backed notes (ABNs).
Partner
Jingtian & Gongchen
Based on its short maturity and renewable features, the first batch of products attracted widespread attention in the industry. As ABCPs are a derivative of ABNs, they are subject to the same set of regulations. However, the ABCP renewal model has significant implications for asset-backed security, in view of its advantages in improving the efficiency of revitalising the inventory of assets, and there are already cases on its application in practice.
ABCP renewal explained
ABCPs must first be registered within a prescribed period and quota. Once they expire, new paper can be issued directly under the product, and the trust beneficiary rights held by the previous ABCP can be transferred for the newly raised fund. Another advantage is that redemption of the previous ABCP can be completed at the same time, without the need to go through the registration and establishment procedures for the new paper.
In addition, since the payment of the previous ABCP is not directly funded by cash flow of the underlying assets, the payback period of those assets can span across multiple ABCPs. That means there is no need to find new underlying assets in order to issue new paper.
Associate
Jingtian & Gongcheng
Model significance
The model broadens the criteria for access to underlying assets and improves the efficiency of corporate asset activation. Under the traditional asset-backed securitisation model, the maturity of the underlying assets must be no later than the maturity of the asset-backed security (ABS) to ensure timely repayment of the instrument. Under the ABCP renewal model – with the obvious exception of the final batch of assets to be securitised – the repayment source for the paper is not directly derived from the cash flow of the underlying assets, so that the maturity of those assets does not have to be earlier than or equal to the maturity of the previous ABS.
The ABCP renewal model therefore allows assets with longer maturities to be pooled, which enhances the diversity of underlying assets and the efficiency of revitalising the inventory of assets for the original equity holders.
The model simplifies the product establishment process and reduces corporate financing costs. Under the traditional ABS renewal model, it is necessary to complete the liquidation and cancellation of the previous batch of securities, the issuance of the next batch, and the search for and purchase of underlying assets, which is a cumbersome process that can take more than two months. With the ABCP renewal model, the special plan does not need to be re-established and filed after the expiration of each ABS, and the plan manager can issue a new batch of paper within the special plan quota and term, thus eliminating the cumbersome process and cost of traditional ABS renewal, improving the efficiency, and reducing the cost of corporate financing.
The model enriches investor choice. The shorter maturity of a single batch of securities under the ABCP renewal model makes it more attractive to investors who prefer shorter maturities. Investors who want to participate in the long-term investment can still choose to buy a new batch of paper when it is renewed by the program manager.
Legal points
Use of proceeds. According to the Regulations on the Administration of Asset Securitisation Business of Securities Companies and Subsidiaries of Fund Management Companies issued in 2014 by the China Securities and Regulatory Commission, the manager shall pay the ABS proceeds to the original equity holders in a timely manner as agreed. We understand that the above provision is to protect the interests of the original equity holders by restricting the use of the proceeds specifically for the payment of the purchase price of the underlying assets, with the implicit premise that the proceeds are used for the purchase of the underlying assets.
Under the ABCP renewal model, the proceeds of the renewed ABS were used as consideration for the transfer of the previous ABS interest, not for the purchase of the underlying assets, and therefore should not be paid to the original equity holders and do not violate the requirements of the regulations.
Whether “capital pooling” is involved. The Guiding Opinions on Regulating Asset Management Business of Financial Institutions stipulate financial institutions shall not conduct or participate in capital pooling with rolling issuance, pooling operation and separate pricing characteristics. We understand that although ABS under the ABCP renewal model has certain similarities with the above fund pooling business, the opinions and their supporting regulations explicitly do not apply to ABS business.
In addition, the regulatory intent is to prohibit capital pooling in order to prevent financial institutions from damaging investors’ interests by borrowing new debt to repay the old, disconnecting funds from assets, and inadequate information disclosure. ABS under the ABCP renewal model, however, is a flexible issuance arrangement based on the existence of real underlying assets and adequate information disclosure, which does not harm investors’ interests and therefore should not be considered as capital pooling.
Handling of failed issuance of renewed ABS. Referring to the existing ABCP model, the funds raised through a new batch of paper on a rolling basis at the maturity of a single ABS issue are used as a source of repayment for the previous batch. In view of the risk of failure of renewal issuance, ABS products should improve product safety through structuring design and credit enhancement arrangements.
To address the risk of failure of a new ABS batch, ABS products may set up risk mitigation measures by referring to the ABCP model, such as introducing liquidity support institutions to provide liquidity support to ensure full repayment of the previous ABS in the event of failure of a renewal issuance. In addition, in the case of a failed renewal issuance, the original equity holders may be required to make a liquidation repurchase of the underlying assets and complete the repayment through repurchase payments.
Matthew Ching is a partner and Zhang Dong is an associate at Jingtian & Gongcheng. Zhang Antong, a paralegal at the firm, also contributed to the article
45/F, K. Wah Centre
1010 Huai Hai M. Road
Shanghai 200031, China
Tel: +86 135 8571 1176
E-mail:
