Asset-Backed Commercial Paper (ABCP)

Asset-Backed Commercial Paper (ABCP) is a short-term secured money market instrument issued by corporates, banks, and other all-India financial institutions. It is issued for 90 days to 270 days to meet the short-term working capital requirements of the issuer. The unique part about this instrument is that, unlike normal commercial paper, it is secured by assets.

Understanding Asset-Backed Commercial Paper

ABCP is a money market instrument issued to meet the issuer's working capital requirements, having the tenor between 90 days to 270 days. It is backed by collateral that secures the money of the lenders who purchase such commercial papers. The assets used as collateral by the issuer can be trade receivables of the issuing entity.

The ABCP are issued at a discount independently determined by the market forces and redeemed at par. These are issued to individuals, banks, corporates, etc. The pricing of such papers is between the prevailing rate of the commercial banks and the money market rate.

Simply put, ABCP is a promissory note secured with collateral, freely transferable through endorsement and negotiable, with a fixed maturity period.

Features of Asset-Backed Commercial Papers

• Large monetary units issue ABCP to meet their working capital needs.
• It has a fixed maturity period, which is a minimum of 90 days and cannot be more than 270 days.
• It is secured by the collateral, like the receivables of the issuing entity. These receivables are the assets like secured loans whose proceeds can be used to pay off in case of default.
• ABCP carries a high credit rating and is backed by highly rated assets.
• The financing terms and amounts of ABCP are very flexible, which helps in providing liquidity to the money market.

Difference between Commercial Paper and Asset-Backed Commercial Paper

Commercial Paper is an unsecured short-term money market instrument issued to meet the working capital requirements with a fixed maturity period. These are freely transferable and can be used as a negotiable instrument.

Asset-Backed Commercial Paper is also a short-term money market instrument that is freely transferable and can be used as a negotiable instrument with a fixed redemption period. But, it is secured by the collateral, generally the trade receivables of the issuing authority.

The typical commercial paper can have a minimum tenor of 7 days, which can go up to 1 year; in contrast, the ABCP can have a maturity period between 90 days to 270 days.

Therefore, we can infer that the ABCP is slightly different from a typical Commercial Paper; it only differs due to the presence of collateral.

Advantages of Asset-Backed Commercial Papers

• For issuing ABCP, no prior approval from regulatory authorities is needed.
• ABCP carries lower risk as compared to other money market instruments.
• The ABCP provides additional security to the investors, as the issuing authority can isolate the collateralized asset from bankruptcy risk.
• Only the big corporates with high credit ratings could issue the typical commercial paper. But, due to the presence of collateral, the ABCP can be issued even by small companies.
• The ABCP can be held in dematerialized form.

Disadvantages of Asset-Backed Commercial Papers

• Though ABCP is secured by collateral, the assessment of overall risk becomes difficult due to the presence of complex terms of credit enhancement.
• The mismatch between the timings of cash flow from collateralized receivables and the redemption of ABCP could be a matter of concern.
• The underlying collateralized assets are traded in the secondary market; this could result in improper risk assessment by the banks on the receivables.
• Despite being backed by the collateralized asset, there are still chances of risk in case of disruption in the underlying asset market. This could result in squaring off the positions of investors of ABCP.
• The ABCP possesses the same risk carried by CDOs (collateralized debt obligations). The pool of debts secures ABCP and CDOs, and in case of failure of debt obligations, the situation of default and financial crisis could rise.

The Bottom Line

An Asset-Backed Commercial Paper is one the most secure form of money market instrument. Unlike Commercial Paper, it is secured by the asset given by the borrower. This is the only differential element from commercial paper, making it more popular among other money market financial instruments.