As the blame game starts after a credit crunch in a corner of Canada's asset-backed commercial paper market, it is emerging that several red flags were raised in the past year about these unique short-term debt investments.
In a June 2006 report, rating agency Standard & Poor's pointed out that Canada's ABCP market was one of a kind in its acceptance of products with "extremely limited-use liquidity support".
The phrase is prophetic, in hindsight. The market for ABCP issued by groups other than Canada's big banks froze up last week when issuers of the instruments turned to financial backers for emergency funding when they were unable to find takers for maturing paper as buyers took fright.
Those backers, mostly international banks operating in Canada, refused to throw issuers a lifeline, citing clauses in the ABCP agreements requiring them to step up only in the event of a "general market disruption" - a loosely defined term and a situation that the banks said had not taken place.
"Conduits with this type of liquidity backup likely would not receive an investment-grade rating from Standard & Poor's," Toronto-based S&P primary credit analyst Maria Rabiasz and two other S&P analysts wrote in the 2006 report.
At the time, and still today, Toronto-based DBRS is the only rating group to rate Canadian non-bank ABCP, which are short-term debt instruments invested in assets such as mortgages and corporate credit.
DBRS handed most of this paper its top R-1 rating, a lure to investors who now want to know how many of these seemingly safe investments went sour. Players in the sector would have ended up in default, but for a bail-out drawn up late last week by 10 large market participants.
Rabiasz and her colleagues urged investors to request multiple rating opinions on the paper. But S&P rival Moody's has also been concerned for some time about the lack of iron-clad funding backstops in non-bank ABCP contracts, Charles Gamm, vice-president and senior credit officer at ratings agency Moody's said.
"Moody's has always stated that this type of liquidity facility is not consistent with our highest short-term rating, which we call Prime-1," Gamm told Reuters. The market for this specialised commercial paper is worth about C$35 billion ($33 billion). It grew rapidly in recent years as companies and money market funds looking for liquid investments with good returns for their cash piled in.
DBRS itself became concerned late last year, albeit not with the contract's liquidity clauses, but with the types of investments that some of the non-bank ABCP issuers were making, according to Canada's Globe and Mail newspaper.
That led the rating agency to firm up its ABCP investment criteria in January. DBRS also told the newspaper it has launched a review of the way it rates ABCP. The rating agency was not available for comment.
In May, Edward Devlin, Canadian portfolio manager at Pacific Investment Management Co (Pimco), the world's largest bond manager, warned in an article of imprudent risk-taking in the ABCP market. "In hindsight, this was not DBRS's finest hour," Devlin told Reuters.
But he is wary of blaming DBRS for the market freeze, which has resulted in several companies being unable to access their working capital because of a 60-day standstill clause in the bail-out plan. "We at Pimco took the rating agencies' rating as just one opinion that we factor into our investment process... As an investor it is our fiduciary responsibility to do those things," he said.
But others said they depend heavily on agencies. "It is not our core business, so we have to rely on some credible indicators and outside expertise," said Terence Chandler, president of the small mining company Redcorp Ventures Ltd, which has C$90 million of its cash frozen in non-bank ABCP.
DBRS is not alone among rating agencies in drawing fire in recent weeks as cracks appear in credit markets around the world, sparked originally by rising defaults in the US subprime mortgage market. S&P, Moody's and Fitch have all come in for criticism and a US senator has called for a review of rating agencies' role in giving strong ratings to risky subprime mortgage securities.