Asset-backed commercial paper (ABCP) is a form of commercial paper that is collateralized by other financial assets. ABCP is typically a short-term instrument that matures between 1 and 270 days (average of 30 days) from issuance and is issued by an Asset-backed commercial paper program or Conduit.
A conduit is set up by a sponsoring financial institution. The sole purpose of a conduit is to purchase and hold financial assets from a variety of asset sellers. The conduit finances the assets by selling asset-backed commercial paper to outside investors such as money market funds or other “safe asset” investors like retirement funds.
The financial assets that serve as collateral for ABCP are ordinarily a mix of many different assets, mostly asset-backed securities (ABS), residential mortgages, commercial loans and CDOs. Most of the assets are AAA-rated, some are un-rated assets generated by the sponsor financial institution, the mixture are jointly judged to have a low risk of bankruptcy by a ratings agency. The asset origins are mostly Unites States (68%), Germany (15%) and United Kingdom (10%). However, in 2007-2008 many of these assets performed poorer than expected, making buyers much less willing to purchase ABCP or rollover.
As market became unwilling to purchase ABCP, this caused trouble for financial institutions that had relied on sales of ABCP to obtain funds for use in longer-term investments (see Maturity mismatch). For example, as one form of the ABCP program, the structured investment vehicles (SIVs) set up by some commercial banks financed their longer-term, higher-yield investing through sales of ABCP. This had been very profitable when ABCP was considered safe (so that ABCP buyers accepted a low interest rate). When some asset prices dropped, investors are less willing to buy or rollover ABCP. This forced SIVs to quickly liquidate their longer-term investments at a substantial loss. The losses together with the panic in liquidity market form a liquidity shock to the banking sector, which helped the contagion of the crisis.
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