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US structured finance

Real reform is being implemented in many segments of US markets. Corporate funding has benefited greatly by this process. Funding cost spreads for US corporations (between rates paid by high-yield growth firms and those of high-grade firms) have narrowed from nearly 8% last October to around 4% today. This trend propelled US debt and equity markets out of an awful slump.

More is needed, however. For the past five years, US corporations have tolerated a volatility of funding costs not seen since the early 1990s. This adverse trend began within weeks after the SEC adopted 1998 changes to Rule 2a-7 under the Investment Company Act of 1940. Those changes disrupted corporate funding access to low-cost, short-term funds. The rules actually favour entities that employ abusive structures similar to those used by Enron and others.

Since 1998, corporate debt markets have endured seven crises, only one of which coincided with external factors (the events of September11, 2001). The latest crisis, which began last May and peaked in the fall, was overcome by the combined efforts of key US legislators and members of the Financial Accounting Standards Board (FASB). Recently proposed amendments to FASB Statement 140 will, it appears, finish the current round of Gaap reforms.

Despite recent success, spreads remain roughly 2% higher than during the not-too-hot, not-too-cool market that began when the SEC adopted Rule 3a-7 under the Investment Company Act of 1940 (1992) and ended when the SEC implemented the 1998 amendments to Rule 2a-7.

The SEC's staff had been told that the 1998 rules would disrupt vital corporate liquidity sources, but failed to accept several recommended changes. To its credit, when markets reacted badly, the staff provided all the relief it could (during the fall of 1998). That relief helped to end the so-called Hedge Fund Crisis.

The staff could only grandfather existing transactions, however. As a consequence, volatility crises reappeared within a couple of years.

The SEC itself must make the changes necessary to stabilize markets. Recommendations for appropriate relief are before the SEC. The proposals enhance investor protection while opening markets to greater stability through the use of responsible structured funding procedures that have been restrained for the past five years.

Reforms from FASB, Congress and others have helped to restore confidence in US markets. Only by removing the unreasonable restraints imposed in 1998, however, are we likely to see a return to the competitive and stable corporate debt markets the US enjoyed in the mid-1990s.

Legal structures to foster stable corporate liquidity are available. There must, of course, be assurance that those structures will not be abused. Implementation of appropriate amendments to Rule 2a-7, however, is now key to restoring market confidence.

It's up to the SEC.

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