Throughout his life, Alan Jones's father invested his money conservatively, favouring bonds and GICs and avoiding even mutual funds as too risky.
When he died in late 2006 at age 87, Alan Jones and his sister decided to continue with the conservative strategy to ensure their mother's retirement income would be safe. In the spring of 2007, they moved more than $500,000 into three short-term investment trusts, assured by their investment adviser that the funds were guaranteed by big banks and had the highest possible credit rating.
“It was never called asset-backed commercial paper,” Mr. Jones said. “I'd never even heard that term until August.”
Within a few months, the Nanaimo, B.C., wholesale nursery worker would learn that his mother's investments were caught up in a national meltdown affecting the market for non-bank asset-backed commercial paper – an obscure investment product many other retail investors had never heard of either.
Guilt was just one of the emotions that racked Mr. Jones, whose mother died at age 92, just three months after the ABCP market seized up.
“I was a little bit angry, but more disturbed and embarrassed, and obviously worried,” he recalls.
Over the year since the ABCP crisis hit, both regulators and insiders in the investment industry have heard hundreds of similar stories from individual investors.
One of the biggest surprises to emerge from the almost year-long restructuring process has been the discovery that so many ordinary, retail investors owned third-party ABCP – a complex product originally created for institutional buyers and sold in the so-called “exempt” market, which means it receives virtually no regulatory scrutiny.
At least 2,000 retail investors owned the paper, based on investment firms' disclosures. While that's a tiny number compared with the more than two million people estimated to have full-service brokerage accounts in Canada, the financial pain and stress for each of those holders has been intense.
Interviews with retail ABCP holders paint a consistent picture of ultraconservative investors seeking safe vehicles for their money. Most went to their financial advisers asking for GICs, treasury bills or similar products. Instead, they ended up with a product that, despite guarantees and high ratings, collapsed when the market was blindsided by the credit crunch because the backing banks that were supposed to support the paper used an out clause.
Since the non-bank ABCP market collapsed last summer, teams of lawyers and top financial industry players have battled through high-stakes negotiations to try to restructure $33-billion worth of notes. A proposal received court approval in June, but it remains tied up in an appeal by corporate investors and will need a ruling by the Ontario Court of Appeal before it proceeds.
As the saga limps closer to a resolution, investors look for answers and where to lay blame. They have lots of suspects to choose from in the financial system, ranging from their brokers to regulators and the bond raters that facilitated the sale of ABCP, all the way to the companies that manufactured these instruments in the first place.
The customers relied on their brokers. Brokers, in turn, say they relied on their firms' stamps of approval to market the product. The firms involved in selling the paper say they placed their faith almost entirely in the top-tier ratings the products had received from debt-rating agency DBRS Ltd. And DBRS says it believed the paper was being sold in the exempt market to sophisticated investors.
As good as GICs
One common theme among retail ABCP investors is that most report they were pitched the product as something that was the equivalent of plain-vanilla GICs – fixed-term deposits with guaranteed principal protection and a set rate of return.
ABCP notes, while highly rated by DBRS Ltd., had no outright guarantee that the principal would be returned. Their interest payments and return of principal depended on the performance of a portfolio of assets underlying the notes. In some cases, those assets were familiar types such as credit card receivables and mortgages. For most of the frozen paper, however, the assets were far more complex financial derivatives.
