In the face of the coronavirus (“COVID-19”) pandemic, the U.S. Federal Reserve Board (the “Fed”) and the U.S. federal banking agencies have announced several market and supervisory actions to address the sudden market stress and strain.

The Fed is the central bank of the United States and a banking regulator, and it is taking a series of actions similar to some of those taken during the 2007–2008 financial crisis. The Office of the Comptroller of the Currency (the OCC) and the Federal Deposit Insurance Corporation (the FDIC) are the other U.S. federal banking regulators. The actions described below are aimed to assist banks, businesses and consumers, all of whom face unique challenges as a result of the sudden closure of businesses and market volatility. In doing so, the Fed is drawing upon its authority under Section 13(3) of the Federal Reserve Act. As distinct from the last financial crisis, however, these actions appear to be in reaction to shut downs in the real economy and the need for credit to be extended to a range of borrowers, rather than a perceived seizing up of the liquidity and credit of the financial institutions themselves.

The Fed’s Commercial Paper Funding Facility

The Fed announced on March 17 the establishment of a Commercial Paper Funding Facility (CPFF). In the last financial crisis, the seizing up of the commercial paper market was viewed as having significant knock on effects, including on money market mutual funds. The Fed aims to encourage continued term lending in the commercial paper market by eliminating the risk that eligible issuers of commercial paper will not be able to repay investors by rolling over their maturing commercial paper obligations.

• Fed Liquidity Facility. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase unsecured and asset-backed commercial paper rated A1/P1 (as of March 17, 2020) directly from eligible companies.^[1]
• Treasury Funding. The Federal Reserve Bank of New York (the FRBNY) will provide financing to the SPV on a recourse basis, and the obligation of the SPV to the FRBNY will be secured by all of the assets of the SPV. As part of the CPFF, the U.S. Treasury will provide $10 billion of credit protection to the FRBNY from its Exchange Stabilization Fund (ESF).
• Eligible Issuers of CP. The SPV will purchase from eligible issuers three-month U.S. dollar-denominated commercial paper through the FRBNY’s primary dealers. Eligible issuers are U.S. issuers of commercial paper, including U.S. issuers with a foreign parent company.
• Limits on SPV Purchases. The SPV may not own more than the greatest amount of U.S. dollar-denominated commercial paper of a single issuer that the issuer had outstanding on any day between March 16, 2019 and March 16, 2020. In addition, the special purpose vehicle will not purchase additional commercial paper from an issuer whose total commercial paper outstanding to all investors (including the [SPV]) equals or exceeds the issuer’s limit.
• SPV Pricing. The CPFF’s pricing will be based on the then-current three-month overnight index swap rate plus 200 basis points. Each issuer’s facility fee (payable at the time the issuer registers to use the CPFF) will be equal to 10 basis points of the maximum amount of its commercial paper the special purpose vehicle may own.
• One Year Facility. Absent Fed extension, the CPFF will terminate on March 17, 2021. The FRBNY will continue to fund the special purpose vehicle after such date until its underlying assets mature.

The Fed has established the CPFF under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary.

The Fed’s Primary Dealer Credit Facility

In a parallel action, the Fed announced, on March 17, 2020, the establishment of a Primary Dealer Credit Facility (PDCFH).

• Broad Range of Collateral. Under the PDCF, primary dealers of the FRBNY will have access to credit that may be collateralized by, among other things, investment grade corporate debt securities, international agency securities, commercial paper, municipal bonds, mortgage-backed securities, asset backed securities, as well as certain equity securities.^[2] Foreign currency denominated securities are not among the eligible collateral, however. The Fed has also kept open the possibility of adding additional collateral in the future.
• Interest Rate. The FRBNY will offer overnight and term funding with maturities up to 90 days beginning on March 20. The interest rate charged will be the primary credit rate, or discount rate, at the FRBNY. Loans will be made recourse to the primary dealer entity.
• Six Month Facility. The PDCF will be in place for the next six months, unless extended.

This facility was also established by the Fed under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary.

Easing of Capital Requirements

The Fed, OCC and FDIC also announced on March 17 a technical change to their capital regulations to phase in gradually the restrictions on capital distributions and discretionary bonus payments that automatically apply if a bank’s capital levels decline. The change was made by the issuance of interim final rule that will be effective upon its publication in the Federal Register (expected in a few days after the announcement).

• The interim rule revises the definition of “eligible retained income” for all depository institutions, bank holding companies and savings and loan holding companies subject to the agencies’ capital rule. The revised definition will make limitations on capital distributions that would have been automatic instead apply more gradually.
• This interim final rule was released in tandem with a statement by the agencies urging banking organizations to use their capital and liquidity buffers as they respond to the challenges presented by the effects of the coronavirus.
• The agencies noted that the changes made by the interim final rule do not impact other rules that may limit capital distributions or discretionary bonus payments.

Fed Discount Window and Reserve Requirements

The Fed announced on March 15 (a Sunday) that it would cut its benchmark federal funds rate by a full percentage point to zero. As of the date of this publication, the Fed Funds target rate was in a range of 0 to 0.25 percent, down from a range of 1 to 1.25 percent.

• Aiming to instill confidence in the market, a group of major banks announced they had accessed the Fed Discount Window (which in normal circumstances might be seen as a sign of financial weakness) shortly after the Fed and other banking agencies urged banks to do so on March 16.^[3] On March 15, the Fed had lowered the primary credit rate by 1.5 percent to 0.25 percent.
• The Fed also reduced the reserve requirement ratios to zero percent on March 15, 2020.^[4] This reduction will be effective on March 26, 2020, which marks the beginning of the next reserve maintenance period. The Fed has not indicated whether weekly reporting of deposits will continue.

Also on March 15, the Fed, together with the European Central Bank, Bank of England, Bank of Japan and the Swiss National Bank, announced coordinated action to enhance liquidity though standing U.S. dollar liquidity swap line arrangements. The pricing on such arrangements will be the U.S. dollar overnight index swap rate plus 25 basis points, which represents a reduction in the rate by 25 basis points.

Stay Tuned

We will continue to monitor legislative, supervisory and market actions taken by bank regulatory agencies as events unfold. Given the market developments since the impact of the pandemic has been absorbed, we anticipate regular developments in this space.

Footnotes