Yesterday, on March 18, 2020, the Board of Governors of the Federal Reserve System (“Board”) announced the creation of a Money Market Mutual Fund Liquidity Facility (“MMLF”) to provide liquidity support to money market mutual funds (“MMMFs”) by facilitating their sale of certain assets in order to meet redemption requests. Under the MMLF, the Federal Reserve Bank of Boston (“FRBB”) will provide secured, non-recourse advances to financial institutions to finance their purchase of certain higher-quality assets from MMMFs. In connection with the creation of the MMLF, the Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation issued an interim final rule designed to neutralize the effect of transactions with the MMLF on participating financial institutions’ risk-based and leverage capital ratios. These steps should have the effect of both supporting the liquidity of the underlying assets that serve as eligible collateral under the MMLF and limiting fire-sale losses at MMMFs should they need to liquidate assets to meet redemption requests.
The MMLF will be similar in certain respects to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF, that the Board established in September 2008 to help MMMFs that held asset-backed commercial paper (“ABCP”) meet investors' demands for redemptions, and to foster liquidity in the ABCP market and money markets more generally. In contrast, however, the MMLF will include a much broader range of eligible collateral than the 2008 AMLF, including U.S. Treasuries, U.S. agency-backed securities, government-sponsored enterprise (“GSE”) securities, ABCP, and unsecured commercial paper of any maturity. The breadth of eligible collateral suggests that the Board intends for the new MMLF to a play a more extensive role in supporting liquidity in financial markets rather than bolster liquidity for a specific asset class.
The MMLF is the third special liquidity program that the Board has established or announced this week using its emergency powers under section 13(3) of the Federal Reserve Act, including a new Commercial Paper Funding Facility and Primary Dealer Credit Facility, as the Board seeks to stabilize financial markets and facilitate the availability of credit to businesses and households in light of the economic conditions caused by the COVID-19 pandemic. As with the Commercial Paper Funding Facility, the MMLF will be supported by a $10 billion backstop from the U.S. Department of the Treasury’s Exchange Stabilization Fund.
This alert summarizes the key parameters of the new MMLF, which are set forth in a term sheet that will be followed by more detailed terms and conditions once finalized by the Board. The Board also will publish an operational calendar that specifies the start date of the MMLF; in the interim, eligible collateral purchased from March 18, 2020 until the MMLF’s start date will be able to collateralize future borrowings under the facility.
Participant Eligibility Requirements
Eligible borrowers from the FRBB under the facility will be U.S. depository institutions, U.S. bank holding companies and their U.S. broker-dealer subsidiaries,[1] and U.S. branches and agencies of foreign banks.
MMMFs eligible to sell collateral to borrowers under the facility will be funds identifying as prime money market funds in Securities and Exchange Commission Form N-MFP filings.
Eligible Collateral and Valuation
An eligible borrower will be able to pledge to the FRBB the following types of collateral purchased from an eligible MMMF:
- U.S. Treasury securities;
- U.S. agency securities;
- GSE securities;
- ABCP issued by a U.S. issuer that is rated, at the time of purchase from the MMMF or pledge to the FRBB, at least A1, F1, or P1 by at least two major rating agencies or, if rated by only one major rating agency, within the top rating category of that agency; and
-
Unsecured commercial paper that is rated, at the time of purchase from the MMMF or pledge to the FRBB, at least A1, F1, or P1 by at least two major rating agencies or, if rated by only one major rating agency, within the top rating category of that agency.
The term sheet also indicates that the MMLF “may” accept as collateral receivables from “certain” repurchase agreements.
Assets purchased from March 18, 2020 until the opening of the MMLF will be able to serve as eligible collateral, but once the MMLF opens, the borrower must purchase collateral concurrently with the borrowing for the collateral to be eligible.
Collateral will be valued using amortized cost or fair value. ABCP and unsecured commercial paper will be valued using amortized cost.
Advance Rate and Other Key Terms
The interest rate of advances under the facility will be priced as follows:
There will be no fees for participating in the facility.
Advances will be made without recourse to the borrower, which means that borrowers will bear no credit risk if the issuer of the collateral defaults.
The maturity of an advance will equal the maturity date of the pledged collateral, not to exceed 12 months.
Termination Date
The MMLF will cease making new advances after September 30, 2020, unless the Board extends the facility as conditions warrant.
Regulatory Capital Treatment
Participation in the MMLF will cause an increase in the size of borrowers’ balance sheets because borrowers must acquire and hold the eligible collateral. Absent relief, the regulatory capital rules could therefore disincentivize participation by causing an increase in borrowers’ capital requirements.
To address this issue, the interim final rule issued by the Board, OCC, and FDIC excludes the effects of purchasing assets in connection with the MMLF from a banking organization’s regulatory capital requirements. It does so by permitting a banking organization to exclude non-recourse exposures acquired as part of the MMLF from the denominator of its risk-based and leverage capital ratios – risk-weighted assets (the denominator of risk-based capital ratios), average total consolidated assets (the denominator of the Tier 1 leverage ratio), and total leverage exposure (the denominator of the supplementary leverage ratio).
The interim final rule is effective as of its publication in the Federal Register, and the agencies will accept comments for 45 days thereafter.
Covington & Burling LLP’s Financial Services attorneys have deep experience guiding U.S. and non-U.S. financial institutions through the most challenging circumstances, including the 2008-09 financial crisis. Our team, which includes former senior federal regulators, stands ready to advise financial institutions as they navigate the impact of COVID-19 on the economy and the financial markets.
If you have any questions concerning the material discussed in this client alert, please contact the members of our Financial Services practice below.
[1] There is ambiguity under the term sheet as to whether a U.S. intermediate holding company of a foreign bank, or its U.S. broker-dealer subsidiaries, would be eligible to participate as a borrower.
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