ANALYZING THE CANADIAN THIRD-PARTY ABCP LIQUIDITY CRISIS AND RESTRUCTURING THROUGH THE LENSES OF SECURITIES AND INSOLVENCY LAW VIRGINIA E. TORRIE A THESIS SUBMITTED TO THE FACULTY OF GRADUATE STUDIES IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FORTHEDEGREEOF MASTER OF LA WS GRADUATE PROGRAM IN LAW YORK UNIVERSITY TORONTO, ONTARIO APRIL 2010 Library and Archives Bibliothéque et 1*1 Canada Archives Canada Published Heritage Direction du Branch Patrimoine de Pédition 395 Wellington Street 395, rue Wellington OttawaONK1A0N4 Ottawa ON K1A 0N4 Canada Canada Yourfile Votre reference ISBN: 978-0-494-62461-6 Ourfile Notre reference ISBN: 978-0-494-62461-6 NOTICE: AVIS: The author has granted a non- Uauteur a accordé une licence non exclusive exclusive license allowing Library and permettant å la Bibliothéque et Archives Archives Canada to reproduce, Canada de reproduire, publier, archiver, publish, archive, preserve, conserve, sauvegarder, conserver, transmettre au public communicate to the public by par telecommunication ou par 1'lnternet, préter, telecommunication or on the Internet, distribuer et vendre des théses partout dans le loan, distribute and seil theses monde, å des fins commerciales ou autres, sur worldwide, for commercial or non- support microforme, papier, électronique et/ou commercial purposes, in microform, autres formats. paper, electronic and/or any other formats. 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While these forms may be included Bien que ces formulaires aient inclus dans in the document page count, their la pagination, il n'y aura aucun contenu removal does not represent any loss manquant. of content from the thesis. 1+1 Canada ANALYZING THE CANADIAN THIRD-PARTY ABCP LIQUIDITY CRISIS AND RESTRUCTURING THROUGH THE LENSES OF SECURITIES AND INSOLVENCY LAW by Virginia E. Torrie By virtue of submitting this document electronically, the author certifies that this is a true electronic equivalent of the copy of the thesis approved by York University for the award of the degree. No alternation of the content has occurred and if there are any minor variations in formatting, they are as a result of the conversion to Adobe Acrobat format [or similar software application). Examination Committee members: 1. Stephanie Ben-Ishai 2. Mary Condon 3. Robin Schwill 4. Benjamin Geva 5. Richard LeBlanc ABSTRACT The C$32 billion third-party Asset-Backed Commercial Paper (ABCP) liquidity crisis has arguably been the most visible impact of the American subprime mortgage crisis in Canada. This thesis examines this event as follows: Part 1 focuses on the securities law aspects of the crisis; Part 2 analyzes the restructuring from an insolvency law perspective. Investigations have revealed that ABCP was insufficiently regulated, leaving open the possibility of a liquidity crisis. Accordingly, the first part of this thesis analyzes this event from a securities law perspective and puts forth a series of recommendations to address regulatory failures. The restructuring of 20 third-party ABCP trusts under the Companies Creditors' Arrangement Act represent one of the most creative uses of the statute in recent history. Therefore, the second part of this thesis adopts an insolvency law perspective in analyzing several features of this precedent setting case and the Plan of Arrangement. IV TABLE OF CONTENTS Abstract iv ListofTables vi List of Figures vii Introduction 1 A. Risky ABCP Business Practices and Securities Law 3 B. The Insolvency of the Canadian Third-Party ABCP Market 6 C. Literature Review 8 D. Methodology 12 E. Roadmap 13 Part 1: Securities Regulation and the Third-Party ABCP Liquidity Crisis 15 A. The (Faulty) Structure of Canadian Third-Party ABCP Securitization 19 i. The Third-Party ABCP Market and Financial Failure 19 ii. Why Third-Party ABCP Experienced a Liquidity Crisis 32 a. Disclosure Exemptions and Reliance on Credit Rating Agencies 32 b. An Investor Confidence Crisis and The Failure of Liquidity Agreements... 42 c. Investor Protection: Retail Investors in Third-Party ABCP 50 B. Looking Toward Regulatory Reform 53 i. Situating the Third-Party ABCP Liquidity Crisis amid Securities Market Failures from a Law and Economics Perspective 53 ii. Recommendations for Reform 63 C. Post-Liquidity Crisis: Regulatory Inquiry and Action 72 D. Conclusion 103 Part 2: Restructuring the Third-Party ABCP Market under the CCAA 106 A. CCAA Restructuring Proceedings 107 i. Accessing the CCAA 107 ii. The CCAA Plan 113 B. A Precedent-Setting Case: Applause and Critique 121 i. Retail Investors in Third-Party ABCP 121 ii. Third-Party ABCP: A Pseudo-Prepackaged Bankruptcy and Precedent-Setting Case 131 C. Conclusion 151 Conclusion 154 Appendix A: Timeline of Certain Significant Events in the Third-Party ABCP Liquidity Crisis and Restructuring 159 Appendix B: Glossary of Financial and Legal Terms 162 Bibliography 166 v LIST OF TABLES Table 1: Settlements Reached ConcerningThird-PartyABCP 74 Table 2: Subprime Exposure of Coventree-sponsored Conduits and Note Series 99 vi LIST OF FIGURES Figure 1: Structure of the Canadian Third-Party ABCP Market 21 Figure 2: Third-Party ABCP Conduits as Trusts 22 Figure 3: Tracing the Money in Third-Party ABCP Structures 23 Figure 4: Third-Party ABCP Conduits and CDS Arrangements 27 vu Introduction In August 2007, a C$32 billion sector of Canadian money markets collapsed, evaporating investors' life savings, pension plans and working capital. This event was the most immediate, and to date the most acute, impact of the global financial crisis felt in Canada. The financial failure of this previously little-known money market security, called third-party asset-backed commercial paper (ABCP), has accordingly had significant ramifications for Canadian securities regulation and insolvency law. Set against a backdrop of global economic turmoil, the third-party ABCP liquidity crisis and restructuring are among the many events that have contributed to heightened international scrutiny of financial markets regulation and insolvency procedures. As legal reform in these areas is much anticipated, careful research and analysis of this event and accompanying issues is both necessary and timely in order to inform future regulatory responses and policy-making. The goal of this study is to investigate the financial failure of third-party ABCP, in order to determine the causes of its collapse and assess the court-supervised insolvency that brought about its resolution. My research builds on three prior papers on various aspects of this topic completed as part of my J.D. studies. This 1 study puts forth a series of securities law recommendations to help prevent the recurrence of the third-party ABCP liquidity crisis and offer insight into this groundbreaking insolvency case. The issues I deal with in my thesis are: 1. How can Canadian securities law be improved to overcome the regulatory causes of the third-party ABCP liquidity crisis? 2. How is the restructuring of this segment of Canadian money markets, a case that stretched the parameters of insolvency law under the Companies' Creditors Arrangement Act (CCAA),1 likely to influence Canadian insolvency law in the future? The third-party ABCP liquidity crisis and insolvency were surprising and unusual events in the Canadian legal landscape. Despite its relative obscurity prior to August 2007, the third-party ABCP market's collapse and restructuring have had far reaching effects, underlining the significance of legal reforms in this area for the stability of the broader Canadian economy. The loss of sizeable investments in third- party ABCP by pension funds such as Caisse de depot et placement du Québec (CDPQ), the largest pension fund in Canada, highlight how regulation of securities markets and court-supervised restructurings have the potential to impact hundreds 1 Companies Creditors' Arrangement Act, R.S.C. 1985, c. C-36 [CCAA]. 2 of thousands of individuals.2 Following the outbreak of the third-party ABCP liquidity crisis, Canadian professionals and the public have begun to critically question why sounder securities laws were not in place to prevent this market failure, and whether the unusual restructuring process, expected to be a powerful precedent for future insolvency cases, created a fair result for all investors. The study of the third-party ABCP liquidity crisis and restructuring is thus well deserving of further study in the Canadian context. A. Risky ABCP Business Practices and Securities Law Marking the largest insolvency in Canadian history, the C$32 billion restructuring resulted from a series of events triggered by a loss of investor confidence in the underlying assets of ABCP trusts, which consisted primarily of American consumer receivables (including subprime mortgages). Following the outbreak of the subprime mortgage crisis in the United States, Canadian investors in third-party ABCP were nervous about the quality of the financial assets underlying their