Yesterday, on March 17, 2020, the Board of Governors of the Federal Reserve System (“FRB”) announced the creation of a Primary Dealer Credit Facility (“PDCF”) to provide a liquidity backstop to primary dealers of the Federal Reserve Bank of New York (“FRBNY”), which include the nation’s largest broker-dealers. The PDCF will provide short-term loans to primary dealers in an effort to smooth market functioning and facilitate the availability of credit to businesses and households in light of the economic conditions caused by the COVID-19 pandemic. The PDCF will function as a fully secured loan facility for primary dealers, similar to the Federal Reserve’s discount window for depository institutions.
The PDCF is the second 2008–09 crisis-era special liquidity program that the Federal Reserve has reestablished this week using its emergency powers under section 13(3) of the Federal Reserve Act. The FRB also announced yesterday that it would create a new Commercial Paper Funding Facility, another liquidity backstop that the FRB provided in 2008. During and after the financial crisis, the Primary Dealer Credit Facility provided over $8.95 trillion in loans over the course of almost two years. Unlike the PDCF established in 2008, the new PDCF announced yesterday will provide not only overnight funding, but also term funding with maturities up to 90 days.
This alert summarizes the key parameters of the new PDCF, which are set forth in a term sheet that will be followed by more detailed terms and conditions once finalized by the FRB.
Eligibility Requirements
Only primary dealers of the FRBNY are eligible to participate in the PDCF. There are currently 24 primary dealers, which include the largest U.S. broker-dealers. Primary dealers serve as the trading counterparties for the FRB’s open market operations, and thereby play a key role in the market for U.S. Treasury securities.
To use the facility, a primary dealer must post eligible collateral that is priced by its clearing bank. Collateral that is eligible for pledge includes all collateral eligible for pledge in open market operations, including Treasury strips, as well as investment-grade corporate debt securities, international agency securities, commercial paper, municipal securities, mortgage- and asset-backed securities, and equity securities. All collateral must be investment grade (i.e., BBB- securities and above), except that commercial mortgage-backed securities, collateralized loan obligations, and collateralized debt obligations must be AAA-rated securities. The term sheet indicates that additional collateral may become eligible at a later time and upon further analysis. It also notes that certain equities – exchange traded funds, unit investment trusts, mutual funds, and rights and warrants – would not be eligible for pledge, and that foreign currency–denominated securities are not eligible for pledge “at this time.”
Loan Terms
Interest rate. Loans made under the PDCF will be made at a rate equal to the primary credit rate in effect at the FRBNY offered to depository institutions via the discount window.
Loan size. Loan amounts will be limited to the amount of margin-adjusted eligible collateral pledged by the primary dealer and assigned to the FRBNY’s account at the clearing bank. Pledged collateral will be valued by the Bank of New York Mellon according to a schedule designed to be similar to the margin schedule for lending at the discount window.
Security. Loans made under the PDCF are made with recourse beyond the pledged collateral to the primary dealer entity.
Loan term. Loans will be made available to primary dealers for a term of up to 90 days. Borrowers may prepay loans at any time.
Loan Arrangement
A primary dealer may request PDCF loans through its clearing bank. The clearing bank will verify that sufficient eligible collateral has been pledged, and notify the FRBNY that such collateral has been pledged to the FRBNY’s account. The FRBNY will then transfer the loan amount to the clearing bank for credit to the primary dealer.
Termination Date
The PDCF will cease making short-term loans after six months, unless the Federal Reserve extends the PDCF as conditions warrant.
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.
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