Late in the evening March 18, 2020, the Federal Reserve announced the establishment of a new Money Market Mutual Fund Liquidity Facility (MMLF2020) to enhance the liquidity and functioning of prime money markets. The establishment of MMLF2020 is another example of the Federal Reserve wielding financial crisis era tools to provide liquidity and help stabilize the financial system in the wake of the coronavirus outbreak.
Money market mutual funds were featured prominently in the 2008 financial crisis. On September 16, 2008, the Reserve Primary Fund “broke the buck” - due to redemptions following the Lehman Brothers bankruptcy announcement, the total market value of assets in the Reserve Fund fell below $0.995 per share. Unable to redeem its investors at $1, the fund froze redemptions. Commentators at the time described this as a trigger for a “run” on other money market funds. About a dozen fund companies stepped in to provide financial support for their money market funds, and on September 19, 2008, the U.S. Treasury announced the establishment of a temporary guarantee program to protect shareholders of money market mutual funds. Notably, the Treasury has not announced any such guarantee program in the current crisis, likely as this is a liquidity, not a run, situation.
MMLF2020 resembles a different emergency measure deployed during the financial crisis. In its announcement of MMLF2020, the Federal Reserve stated it is similar in structure to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (“AMLF”) established in September 2008 to help money market mutual funds holding asset-backed commercial paper (“ABCP”) meet investors' demands fo
r redemptions, and to foster liquidity in the ABCP market and money markets more generally.
Why is the Federal Reserve Establishing the MMLF2020?
The spread of the coronavirus has significantly and adversely impacted global financial markets. In particular, sudden disruptions in short-term funding markets have put increasing liquidity pressure on prime money market mutual funds. Given these pressures, prime money market mutual funds have been faced with redemption requests from clients with immediate cash needs in the face of thinner markets for commercial paper and other short-term corporate debt instruments. These prime money market mutual funds will need to sell a significant number of assets to meet these redemptions, which will further increase pressures. By establishing MMLF2020, the Federal Reserve Bank of Boston (“FRBB”) will make loans available to eligible financial institutions secured by assets purchased from money market mutual funds.
As noted above, MMLF2020 is similar to the AMLF program deployed by the Federal Reserve during the financial crisis. There, the Federal Reserve provided nonrecourse loans to financial institutions that used the funding to purchase eligible troubled assets from money market mutual funds. In both the case of MMLF2020 and the AMLF, borrowers serve as conduits in providing liquidity to money market mutual funds, although the money market mutual funds are the primary beneficiaries of the lending facility. Just as is the case for MMLF2020, loans by the AMLF were fully collateralized by the securities purchased by the borrower. As the financial markets improved, in June 2009 the Federal Reserve established further conditions on use of the facility to help ensure that the AMLF was used for its intended purpose of providing a temporary liquidity backstop to money market mutual funds (as opposed to a source of discounted financing). It established redemption thresholds for eligibility, requiring that a money market mutual fund experience material outflows before the ABCP that it sold was eligible collateral for AMLF loans.
The AMLF was closed on February 1, 2010. All loans made under the facility were repaid in full, with interest, in accordance with the terms of the facility. In the wake of the crisis, the SEC amended its rules on money market funds in 2010 and again in 2014. It reduced the interest rate, credit, and liquidity risks of money market portfolios, and required prime institutional money market funds to “float their NAV” (no longer maintain a stable price), also providing money market fund boards with new tools — liquidity fees and redemption gates — to address runs. These reforms undoubtedly improved the resiliency of money market funds, and the MMLF2020 facility provides another tool that prime money market mutual funds may use to manage the impact of increasing redemptions during continued downward pressure on liquidity.
How Will MMLF2020 Work?
According to the initial terms released by the Federal Reserve, the FRBB will extend non-recourse loans to eligible borrowers, taking as collateral certain types of assets purchased from prime money market mutual funds, either concurrently with the borrowing or after March 18, 2020 but before the opening of MMLF2020. Eligible borrowers include all U.S. depository institutions, U.S. bank holding companies (parent companies incorporated in the United States or their U.S. broker-dealer subsidiaries), or U.S. branches or agencies of foreign banks. While savings and loan holding companies were not expressly included as eligible borrowers in the Federal Reserve’s initial term sheet, they were covered by the associated regulatory capital relief suggesting they will be eligible to borrow from the MMLF2020 (discussed below). In short, banks will concurrently purchase high-quality assets from eligible prime money market funds and borrow cash with the same assets from MMLF2020.
As with the Commercial Paper Funding Facility, the Department of Treasury is providing $10 billion of credit protection via the Exchange Stabilization Fund. As noted above, the credit protection is not a guarantee. As of the Emergency Economic Stabilization Act of 2008, these types of guarantees are now prohibited uses of the Emergency Stabilization Fund.
What Money Market Funds are Eligible?
Only prime money market funds are eligible. Prime money market funds generally hold a variety of taxable short-term obligations issued by corporations and banks, as well as repurchase agreements and asset-backed commercial paper. Government money market funds, on the other hand, principally hold obligations of the U.S. government, including obligations of the U.S. Treasury and federal agencies, and are not experiencing the same downward pressure currently found in prime money markets. The SEC’s 2014 money market funds reforms required prime money market funds to have a floating net asset value and establish redemption gates if the fund’s weekly liquid assets fall below 30% of the fund’s total assets.
What Types of Assets are Eligible?
Several types of collateral are eligible, but all are US-based:
- U.S. Treasuries & Fully Guaranteed Agencies
- Securities issued by U.S. Government Sponsored Entities
- Asset-backed commercial paper issued by a U.S. issuer, if at the time purchased from the Fund or pledged to the Federal Reserve it is:
- Rated not lower than A1, F1, or P1 by at least two major rating agencies or,
- If rated by only one major rating agency, is rated within the top rating category by that agency;
- Unsecured commercial paper issued by a U.S. issuer, if at the time purchased from the Fund or pledged to the Federal Reserve it is:
- Rated not lower than A1, F1, or P1 by at least two major rating agencies or,
- If rated by only one major rating agency, is rated within the top rating category by that agency. U.S. Treasuries and fully guaranteed agency securities, securities issued by government-sponsored enterprises, and certain types of commercial paper.
- Receivables from certain repurchase agreements
How Will Assets be Valued?
The collateral valuation will either be amortized cost or fair value. Notably, the Federal Reserve specified that for asset-backed and unsecured commercial paper, the valuation will be amortized cost. This will allow banks to purchase commercial paper at prices more favorable than the current market, where prices are under significant downward pressure.
What is the Cost of Borrowing?
Advances made under MMLF2020 that are secured by U.S. Treasuries & Fully Guaranteed Agencies or securities issued by U.S. government sponsored entities will be made at a rate equal to the Federal Reserve’s discount window prime rate (currently 0.25%).
All other advances will be made at a rate equal to the discount window prime rate plus 100 bps (1.25%).
How Will this Affect A Bank’s Regulatory Capital Treatment?
The Federal Reserve, OCC and FDIC are proposing rules to fully neutralize the impact of a bank or banking holding company’s participation in the facility for purposes of regulatory capital requirements, including risk-based capital and leverage requirements. The prudential regulators intend to fully exempt from risk-based capital and leverage requirements (i) any asset pledged to MMLF2020 and (ii) any asset purchased from an eligible money market fund on or after March 18, 2020 that the firm intends to pledge to MMLF2020 upon opening of the facility. The Federal Reserve established similar relief in connection with the AMLF in 2008.
Can Participating Banks Transact with Affiliate Prime Money Market Funds?
The Federal Reserve has not announced relief that would facilitate increased affiliate transactions. In contrast, when it established the AMLF in 2008, the Federal Reserve concurrently established temporary limited exception from sections 23A and 23B of the Federal Reserve Act, which restrict transactions between a bank and its affiliates. In the absence of these exemptions, banks would have been severely limited in the amount of ABCP they could purchase from an affiliated money market mutual fund, and would have been required to purchase assets from the affiliate at market prices. By lifting that requirement, the Federal Reserve enabled banks to purchase troubled assets at prices higher than current market price.
In addition to relief needed under Sections 23A and 23B of the Federal Reserve Act, US regulated banks seeking to purchase of assets from an affiliated money fund with support of the MMLF2020 will need to address existing banking agency guidance on providing financial support to affiliated investment funds. This guidance required banks to adopt policies and procedures to ensure a bank did not “inappropriately place its resources and reputation at risk for the benefit of the funds’ investors and creditors.” 1 In 2008, the guidance did not prevent banks from supporting affiliate funds, but banks should review their internal policies and procedures, as well as disclosures, regarding such support. The largest US regulated banks will also need to be cognizant of how such support may impact its capital adequacy models used for the annual Comprehensive Capital Analysis and Review “stress tests.”
In 2008, the SEC also provided no-action relief permitting money market mutual funds to sell ABCP to bank affiliates participating in the AMLF at the amortized cost value of the ABCP.2 In the absence of such relief, Section 17(a)(2) of the Investment Company Act makes it unlawful for any affiliated person of a registered investment company, or any affiliated person of such person, acting as principal, to knowingly purchase any security or other property from the investment company. The SEC’s no-action position in 2008 permitted the affected money market funds to engage in these limited affiliated transactions without fear of enforcement action. Banks who seek to participate in the MMLF2020 to purchase assets from affiliate money market mutual funds would require similar relief; they would also require SEC relief to purchase assets at anything other than amortized cost.
It is not clear whether the Federal Reserve or the SEC will establish similar relief for participation in MMLF2020.
Is there a Termination Date?
No new credit extensions will be made after September 30, 2020, unless MMLF2020 is extended by the Federal Reserve.
How Can Banks Participate and What Documentation is Required?
The Federal Reserve has not yet provided additional information on how, specifically, the program will be administered. It will be administered by the FRBB, which also administered the AMLF in 2008. It is not clear whether it will adopt similar practices to administer the MMLDF2020. However, for illustrative purposes, required documentation to participate in the AMLF was posted at www.frbdiscountwindow.org. Participants in the AMLF were not required to have a master account with the Federal Reserve; non-accountholders were permitted to borrow through a correspondent. Borrowers that did not have OC-10 documentation on file with their local Reserve Bank were required to complete a letter of agreement and certain authorizing resolutions signed by the borrower's board of directors.