By Eli Han, Mathew Dickerson and Yi He
The COVID-19 outbreak in the United States has wreaked havoc in the U.S. economy. In response, the U.S. government has taken massive actions to stabilize and stimulate the economy. The U.S. Federal Reserve has delivered a series of extraordinary measures to support the U.S. economy during the escalating COVID-19 pandemic, pledging to buy an unlimited amount of bonds and setting up a series of programs to ensure credit continues to flow to U.S. companies.
While some of the measures announced by the Federal Reserve echo programs established during the 2008 global financial crisis (including the TALF, MMLF, CPFF and PDCF), compared against those earlier programs, the Federal Reserve’s COVID-19 measures are both:
- broader in scope, as they are aimed at supporting all types of companies (large and small) that operate in the real economy and not just financial institutions; and
- greater in magnitude, which is reflective of the increasing severity of the COVID-19 pandemicand the tremendous hardship it is causing to families and businesses in the United States and around the world.
The remainder of this article provides a high-level overview of some of the key measures announced by the Federal Reserve to date. As the COVID-19 situation continues to develop and as other parts of the U.S. government adopt and implement their own extraordinary response measures, the Federal Reserve’s approach and policy toolkit is expected to evolve.
OVERVIEW OF THE FEDERAL RESERVE’S MEASURES
1. Support for Critical Market Functioning – Quantitative Easing Plan
The Federal Open Market Committee (FOMC) of the Federal Reserve System will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy. The FOMC had previously announced it would purchase at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed securities. In addition, the FOMC will include purchases of agency commercial mortgage-backed securities in its agency mortgage-backed security purchases.
2. Provide Liquidity– supporting the flow of credit to employers, consumers, and businesses by establishing new programs that, taken together, will provide up to $300 billion in new financing. The Department of the Treasury, using the Exchange Stabilization Fund (ESF), will provide $30 billion in equity to these facilities.
3. Establishment of Various Facilities
Primary Dealer Credit Facility (PDCF)
- Objective: The PDCF is intended to allow primary dealers to support smooth market functioning and facilitate the availability of credit to businesses and households by providing credit to primary dealers in exchange for a broad range of collateral.
- Overview: Loans will be made available to primary dealers for a term of up to 90 days and may be collateralized by a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities.
Commercial Paper Funding Facility (CPFF)
- Objective: The CPFF is designed to encourage investors to once again feel safe to lend in the commercial paper (CP) market, and to make sure that U.S. CP issuers, including corporate issuers, are able to roll over maturing CPs.
- Overview: The CPFF will serve as a funding backstop to facilitate the issuance of term CPs by eligible issuers. The Federal Reserve Bank of New York will lend, on a recourse basis, to a funding special purpose vehicle (SPV), capitalized by the Department of the Treasury with $10 billion equity investmentfrom the ESF, and loans will be secured by all assets of the SPV. The SPV will purchase 90-day U.S. dollar-denominated CPs, rated at least A1/P1/F1 (with limited exception), issued by eligible issuers, including U.S. corporate issuers and municipalities.
Money Market Mutual Fund Liquidity Facility (MMLF)
- Objective: The MMLF is designed to provide relief for, and liquidity to, money market mutual funds (MMFs) that are prime MMFs, single-state MMFs and other tax-exempt MMFs.
- Overview: The MMLF will serve as a funding backstop for MMFs.Under the MMLF, the Federal Reserve Bank of Boston will make non-recourse loans to eligible financial institutions, secured by high-quality assets purchased by the borrower financial institution from MMFs, without haircuts. Eligible borrowers include all U.S. depository institutions, U.S. bank holding companies and U.S. branches and agencies of foreign banks.
- Eligible collateral under the MMLF includes U.S. Treasuries and fully guaranteed U.S. agency securities, securities issued by U.S. government sponsored entities, CPs and negotiable CDs with a short-term rating within the top rating category, U.S. municipal short-term debt with a maturity less than 12 months and a short-term rating within the top rating category, and variable rate demand notes that can be tendered within 12 months and have a rating in a top rating category.
- MMLF下的合格抵押物包括美国国债和美国主权信用担保的政府机构债务，美国政府发起的机构发行人债务，短期高信用评级的CP 和可兑现CD，短期高信用评级的市政债券，和短期高信用评级的可变利率即期票据。
- Term Asset-Backed Securities Loan Facility (TALF)
- Objective: The TALF is intended to help meet the credit needs of consumers and small businesses by facilitating the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets, and improving the market conditions for ABS more generally.
- Overview: The TALF will serve as a funding backstop to facilitate the issuance of eligible ABS. The Federal Reserve Bank of New York will lend to a funding SPV, capitalized by the Department of the Treasury with $10 billion equity investment, on a recourse basis. The SPV will then make loans to eligible borrowers on a non-recourse basis, secured by certain AAA-rated cash ABS backed by newly and recently originated consumer and small business loans, with the collateral subject to valuation haircuts. The SPV initially will make up to $100 billion of loans available. The loans will have a term of three years.
- Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance andSecondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds
Objective: To allow companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations caused by COVID-19.
Overview: The PMCCFwill serve as a funding backstop for corporate debt issued by eligible issuers. The Federal Reserve Bank of New York will lend to a funding SPV, capitalized by the Department of the Treasury with $10 billion equity investment from the ESF, on a recourse basis and secured by all assets of the SPV. The SPV will then purchase, in the primary market, qualifying bonds from, and make loans to, eligible issuers on a non-recourse basis. This facility is open to U.S. companies headquartered in the United States and with material operations in the United States, which or whose bonds have investment grade ratings, other than companies that are expected to receive direct financial assistance under federal legislation, such as airlines.
Overview: Under the SMCCF, the Federal Reserve Bank of New York will lend to a funding SPV, capitalized by the Department of the Treasury with $10 billion equity investment from the ESF, on a recourse basis and secured by all assets of the SPV. The SPV will purchase in the secondary market corporate bonds issued by U.S. companies with material operations in the United States, whose bonds have investment grade ratings, as well as U.S.-listed exchange-traded bond funds.
- Temporary FIMA Repo Facility
- Objective: This facility is designed to help support the smooth functioning of the U. Treasury securities market by providing other central banks an alternative temporary source of U.S. dollars to sales of U.S. Treasury securities they own in the open market. It should also serve, along with the U.S. dollar liquidity swap lines the Federal Reserve has established with other central banks, to help ease strains in global U.S. dollar funding markets.
- Overview: On March 31, 2020, the Federal Reserve announced the establishment of a temporary repurchase agreement facility for foreign central banks and other international monetary authorities (FIMA Repo Facility). The FIMA Repo Facility will allow FIMA account holders, which consist of central banks and other international monetary authorities with accounts at the Federal Reserve Bank of New York, to enter into repurchase agreements with the Federal Reserve, to temporarily exchange their U.S. Treasury securities for U.S. dollars, which can then be made available to institutions in their home jurisdictions. Under the facility, foreign central banks can temporarily raise dollars by selling U.S. Treasuries to the Federal Reserve’s System Open Market Account and agreeing to buy them back at the maturity of the repurchase agreement. The term of the agreement will be overnight, but can be rolled over as needed. The transaction would be conducted at an interest rate of 25 basis points over the rate on IOER (Interest on Excess Reserves), which generally exceeds private repo rates when the Treasury market is functioning well, so the facility would primarily be used only in unusual circumstances such as those prevailing at present.
4. Other Federal Reserve Actions
- The Federal Reserve established temporary dollar liquidity-swap lines with 14 central banks. The Federal Reserve first announced coordinated action with five central banks (ECB, BoE, and central banks of Canada, Japan, Switzerland), and on March 19 added temporary swap arrangements with 9 more central banks to be in place for at least six months. On March 20, it announced that swaps with the first group of central banks would be conducted daily rather than weekly.
- The expansion of the dollar swap lines allows foreign central banks to meet the needs of companies and financial institutions rushing for dollars as the global payment system undergoes severe strain due to COVID-19.
- Steps to enhance the availability and ease terms for borrowing at the discount window,help encourage more active use of the window by depository institutions to meet unexpected funding needs:
- Discount window: Federal Reserve lending to depository institutions (the “discount window”) plays an important role in supporting the liquidity and stability of the banking system and the effective implementation of monetary policy. By providing ready access to funding, the discount window helps depository institutions manage their liquidity risks efficiently and avoid actions that have negative consequences for their customers, such as withdrawing credit during times of market stress. Thus, the discount window supports the smooth flow of credit to households and businesses.
- Measures: Primary credit rate reduced to 25 bps, term extended to up to 90 days.
- The reduction of the reserve requirement ratios to zero percent to free up funds to support more lending. The reserve requirement is the amount of money that a depository institution must have in its account at a Federal Reserve Bank, as a percentage of its deposit liabilities.
- Guidance encouraging banks to be flexible with customers experiencing financial challenges related to COVID-19 and to utilize their liquidity and capital buffers in doing so。
- FOMC cut the target range for the federal funds rate to 0% to 0.25%.
In addition to the steps above, the Federal Reserve expects to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA.
As the U.S. government’s multifaceted response to the COVID-19 pandemic continues to unfold, it remains to be seen how the Federal Reserve’s monetary policy tools will work together with the U.S. government’s recently announced fiscal policy measures in the CARES Act to deliver maximum results for affected households and businesses.
Market participants are also eagerly waiting to see the extent to which governments and central banks around the world can effectively coordinate their policy measures to revitalize the global economy. As with the virus itself, the economic repercussion of the COVID-19 pandemic knows no borders or ideologies.
Disclaimer: This article provides general information only, which may or may not reflect the most current legal developments and does not constitute legal or other professional advice. Readers should seek appropriate legal advice from counsel in their relevant jurisdiction(s) before taking or refraining from taking any action in reliance on any information contained in this article. Nothing in this article shall create an attorney/client relationship with King & Wood Mallesons LLP or with any lawyer at King & Wood Mallesons LLP.