Asset-Backed Commercial Paper (ABCP)

Definition: Asset-backed commercial paper (ABCP) is a term used in the financial industry to refer to a commercial paper secured by either tangible assets or a company’s property. Asset-backed commercial paper is typically issued by financial institutions and businesses backed by real assets or other commercially valuable assets. ABCPs allow customers with limited access to funds to take out loans fully adjustable in principal and interest and investor demand.

ABCP broadly refers to a loan instrument denominated in commercial paper, which is frequently backed by collateral and may be denominated in commercial paper. ABCPs are collateralized by assets such as inventory, inventory-related goods, property rights, commercial real estate holdings, or even funds invested in these assets. Assets may be collateralized on either a business day or a weekly basis. The collateral is typically offered as part of the initial offer for the loan on an asset-backed basis.

The maturity date of an ABCP is set at no more than 270 days from the date on which the ABCP is first issued. An ABCP may be issued to a borrower who is a corporate borrower and has never obtained a loan offset or secured by real estate property, as long as the aggregate unpaid balance on loan at the end of the 270 days does not exceed the principal amount of the loan. An ABCP may also be issued to a borrower whose financial circumstances have changed substantially since the original loan was made or extended.

Asset-backed commercial paper is backed by the assets of an active lender, typically a financial institution or state agency. Commercial paper issued by commercial banks generally has a shorter maturity period than ABCP and may be asked to be collateralized by assets held by other institutions or individuals. Institutions purchase commercial paper as non-interest-bearing, short-term, unsecured loans. ABCP is purchased by corporations and used to finance manufacturing, distribution, exploration, and maintenance. ABCP has lower interest rates than commercial paper and is backed by the physical property used in the manufacturing process. This property could be physical goods such as inventory or tangible assets such as producer’s goods, machinery, or inventory itself.

ABCP investors will need to monitor market conditions carefully, as the underlying assets’ composition may change over time and changes in underlying liabilities or net worth. The success of ABCP depends in part on investors’ ability to identify when these changes occur and take appropriate action. The use of instruments such as interest rate swap agreements or forward contracts can help facilitate this monitoring. ABCP investors typically receive higher returns than those received by comparable funds and instruments in the investment management industry.