Canada: Bankers’ Acceptance Purchase Facility

The close link between corporate borrowing and derivatives forged by the Canadian Dollar Offered Rate explained why the BoC cited both “the continuous functioning of financial markets” and “financing for small- and medium-size corporate borrowers” in its announcement of the BAPF (BoC 2020h).

The BA market is one of Canada’s “core funding markets” (BoC 2020h). A BA is “a direct and unconditional order from a corporate borrower to draw down against its established line of credit” (Vikstedt and McRae 2020, 3). After a bank lends funds to a borrower, the bank can sell the BA liability on the secondary market; it represents a liability of the borrower but carries the bank’s guarantee. Since BAs stopped carrying issuer names in the 1990s, BAs carried the rating of the guaranteeing bank. In 2017, seven primary dealers^FThe seven dealers were: Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Hongkong and Shanghai Banking Corporation (HSBC), National Bank of Canada (NBC), Royal Bank of Canada (RBC), and Toronto-Dominion (TD) Bank (McRae and Auger 2018, 15). issued 98% of the BA market (McRae and Auger 2018).

Because they are almost always issued by a primary dealer, most BAs are highly rated. The market is also highly liquid; as of March 11, 2020, 91% of the average daily BA trading volume since 2015 carried one-month maturities, with another 8% carrying two- to three-month tenors. Since they still “offer[ed] a relatively attractive yield pickup in the secondary market over [Government of Canada] and provincial treasury bills,” BAs became a favorite of institutional investors, who would purchase new BAs once those it held reached maturity (Vikstedt and McRae 2020, 6). After competing with commercial paper for several decades, BAs became the largest privately issued money market instrument after the Global Financial Crisis (GFC) and accounted for more than 25% of Canada’s money market in 2017, only slightly less than GoC bills (McRae and Auger 2018, 13).

Institutional investors began dumping BAs in March 2020 to weather a storm of outflows related to the pandemic. Canada’s public pension companies, which usually bought CAD 4 billion a week in BAs, became net sellers during the week of March 8, as seen in Figure 2. Meanwhile, businesses drew heavily on their lines of credit. The crisis deterred some larger borrowers from commercial paper, while smaller borrowers drew on lines to fund near-term liabilities (Arora et al. 2020). Each of these factors pushed yields higher.

This credit crunch spilled over to the CDOR, at which banks were “willing to lend their balance sheet to corporate borrowers with existing BA facilities” (Vikstedt and McRae 2020, 9–10). This committed lending rate applied directly to the CAD 90 billion BA market, but—like the London Interbank Offered Rate (LIBOR)—also underpinned a much larger market of derivatives. When the spread of CDOR above the overnight index swaps rate climbed 100 bps above its pre-crisis level near 25 bps, it also threatened some CAD 11 trillion in over-the-counter and exchange-traded derivatives that used CDOR (Bédard-Pagé et al. 2021, 12; McRae and Auger 2018, ii; Vikstedt and McRae 2020, 9–10). BoC staff also referenced the importance of the CDOR in the BoC’s decision to create the BAPF. Of the four papers that evaluate the BAPF, all consider the facility’s effect on CDOR, and none estimate its effect on corporate borrowers.

Source: Bédard-Pagé et al. 2021, 8.

The Government of Canada also discussed the BAPF as business credit and liquidity support in its Economic Response Plan (Department of Finance 2020). The BoC announced the BAPF on the same day it lowered its overnight rate from 1.25% to 0.75% and a day after it had expanded purchases of government debt (BoC 2020f; BoC 2020g).

Section 18 of the Bank of Canada Act (1985) afforded the BoC broad powers in the service of monetary policy and financial stability. Subsection 18(g)(i) allowed the BoC to trade in virtually any security except equities but mandated that the BoC publish a policy in the legal gazette describing the securities and transactions it would undertake.

From 2015 to 2020, the BoC’s policy allowed it to acquire BAs but only by reverse repurchase agreements (BoC 2015).^FIn Canada, these repos are known as purchase and resale agreements (PRAs). On March 18, 2020, the BoC amended the 2015 policy, permitting it to also purchase securities—such as BAs—outright. The amendment allowed such purchases to address financial system stress or monetary policy in support of market functioning.

The BoC clarified that such purchases—known as exceptional transactions—followed the BoC’s authority under 18(g)(i) and were “distinct from” its 18(g)(ii) authority (BoC 2020e). Subsection 18(g)(ii), which has never been invoked, allowed the BoC to purchase securities, including equities, “if the Governor is of the opinion that there is a severe and unusual stress on a financial market or the financial system” (Bank of Canada Act 1985). These powers augmented the BoC’s explicit authority to purchase securities issued or guaranteed by Canada, its provinces, the United States, Japan, the United Kingdom, or European Union member states.

The BoC lobbied for the creation of subsection 18(g)(i) during the Global Financial Crisis. During parliamentary committee hearings, officials from the BoC and Ministry of Finance argued that, when the GFC began, “some of the central banks had more room to move than did” the BoC (Rudin, McKay, and Flaherty 2008). They noted the securities that the Bank of Canada Act explicitly allowed the BoC to purchase—bills of exchange (such as BAs) and promissory notes, in addition to government securities—and that:

The relevance of a number of those securities to the financial markets has decreased over time because of financial innovation . . . for example, we cannot buy, for the purposes of resale, money market securities longer than 180 days. We cannot buy corporate bonds. There is a host. We cannot buy term asset-backed securities. We cannot buy municipal bonds, or we cannot buy corporate commercial paper (Carney and McKay 2008, 6).

Motivated by the legislative constraints, the amendment that created 18(g)(i) used the Bank of England and European Central Bank as models of central banks with broad authorities. When the BoC published its first policy in the Canada Gazette describing the securities it would purchase, its exceptional transactions were limited to repurchase agreements for terms of up to 180 days.

The Bank of Canada Act required the BoC to publish its policy allowing outright transactions in the Canada Gazette. The central bank was then required to wait seven days before enacting its policy.

The Bank of Canada Act (1985, vol. c. B-2, sec. 28) also enabled the minister of finance to appoint auditors of the BoC and to require that those auditors report on bank affairs to the minister “from time to time.”

BoC notices listed two directors in the Treasury auctions and settlement systems team of the Financial Markets Department as key contacts. This indicates that the BAPF used the familiar infrastructure of Treasury auctions to communicate with primary dealers. Other documents do not address further how the BoC implemented the BAPF.

Successful bidders delivered BAs through the CDSX platform, owned and operated by Clearing and Depository Services (CDS) (BoC 2021b; BoC 2020d). Settlement occurred two days later.

The BoC announced the BAPF on March 13, 2020, via market notice and released the facility’s terms and conditions on its website (BoC 2020h). Newspaper archives revealed few acknowledgements of—and no commentary on—the announcement. Nonetheless, BoC researchers estimate that the announcement reduced the BA-OIS spread by 15 bps (Arora et al. 2020). The BoC then released further operational details on the facility via notices on March 17 and 19. The BoC appeared to have increased the amount on offer from CAD 10 billion to CAD 15 billion in the second of these notices (BoC 2020b; BoC 2020c). The same BoC researchers find an additional 20–70-bp decrease in the BA-OIS spread following the announcement of these details (Arora et al. 2020).

After the first operation, Smith (2020) reports “that there is some way to go before stress is reduced in Canadian money markets.” The article offers what may be the only commentary on the BAPF in a major news outlet.^FAnalysts such as those at TD Securities offered more commentary, but efforts to locate those articles failed.

In weekly financial statements, the BAPF appeared as “Bankers’ Acceptances,” a new line on the asset side of the central bank’s balance sheet, shown in Figure 3 along other BoC assets (BoC 1981–2021). The BoC ultimately published transaction-level data for the BAPF, detailing each bond it made eligible for purchase, their amounts, and their price (BoC 2021a).

Note: All other assets included provincial treasury bills and bonds, corporate bonds, and commercial paper.

Source: BoC 2020k, 25.

The BoC did not use a special-purpose vehicle to administer the BAPF.

The announcement of the BAPF did not specify its total size (BoC 2020h). A later notice announced that the BoC would purchase up to CAD 15 billion in BAs and target CAD 10 billion for most auctions (BoC 2020c). Over 24 auctions, the BoC ultimately purchased just more than CAD 47 billion. After the first three operations, the BoC offered to buy CAD 10 billion of BAs in each auction. The BoC offered to purchase CAD 15 billion, CAD 20 billion, and CAD 20 billion in the first three auctions, respectively, and then CAD 10 billion for the remaining auctions (BoC 2020a). Documents do not suggest how the BoC determined how much it would purchase. As Tucker (2009, 11) notes, a market liquidity program should be “catalytic, helping ideally to kick-start the market rather than replace it.” The question is important and more difficult to answer than it is in auctions for central bank money, where the imbalance in reserves is precisely known.

To fund the BAPF, the BoC credited primary dealers’ accounts with reserves held at the BoC.

The BoC allowed the 11 Canadian primary dealers^FThese were Bank of Montreal (BMO) Nesbitt Burns, Casgrain & Company, CIBC World Markets, Desjardins Securities, HSBC Securities, Laurentian Bank Securities, Merrill Lynch, NBC Financial, RBC Dominion Securities, Scotia Capital (subsidiary of Bank of Nova Scotia [BNS or Scotiabank]), and TD Bank. to participate in the BAPF (BoC 2020d). It did not disclose which dealers participated in auctions.

Ahead of each operation, the BoC announced the date, purchase amount, minimum bid rate, settlement date, and maturity range of eligible securities. Between 8:30 and 9:00 on the morning of the operation, participants submitted up to 10 bids. Each identified the security to be sold and its short-term credit rating, the yield a bidder was willing to pay, and the amount a bidder would sell in CAD 5 million increments. The BoC then accepted bids starting with the highest yield rates until the accepted bids exhausted the total amount offered. Successful bidders received the rate they offered (BoC 2020d). Results of the subscribed auctions are shown in Figure 4.

No participant could sell the BoC more than either 12.5% or 25% of a single auction’s offering amount, depending on the dealer’s market share of government bonds. Participants could bid the maximum amount each auction. The BoC did not publish a rationale behind this rule. Because the BoC did not disclose which banks sold which securities, these maximum amounts cannot be imputed.

The BoC had been accustomed to purchasing securities with the intention of reselling them later. No documents indicate that the BoC attempted to make a market in BAs by later selling them. The BAPF was one of the BoC’s first forays into outright purchases of private securities.

The BAPF purchased BAs issued by Canadian banks and branches of foreign banks in Canadian dollars. Though it allowed remaining maturities up to 76 Canadian business days, the BoC set an exact maturity range before each operation. This range encompassed most BAs; 98% of BAs carried one- to three-month maturities (Vikstedt and McRae 2020, 4).

Eligible BAs carried credit ratings of at least R-1 (low) from DBRS Morningstar, representing “good credit quality” (BoC 2020d).

Issuers could be any Canadian bank—including the bidder—but those from banks without access to the Large Value Transfer System (LVTS) must have been prescreened a day prior to auction (BoC 2020d). The LVTS was a real-time gross settlement platform used by large Canadian banks. To facilitate real-time transactions, the BoC granted participants intraday credit secured by collateral pledged to the BoC through CDSX; the BoC was accustomed to reviewing collateral from these banks in a short period of time (Engert, Gravelle, and Howard 2008, 5). The BAPF ultimately purchased securities issued by 10 institutions, nine of which were affiliates of primary dealers (BoC 2021a).

Banks offered a minimum yield called a reserve rate that was expressed as a spread over OIS (BoC 2020d). This rate started at 0.60% and fell to below 0.40% before the BoC increased it for the final two auctions in which banks participated (BoC 2021a). As seen in Figure 5, some successful bidders accepted more than double the reserve rate in the first two auctions. In later auctions, yields settled at the minimum rate, with a much narrower range of yields bid.

Source: BoC 2021a.

As an asset purchase program, the BAPF did not have haircuts.

The BAPF paid prices resulting from its reverse auction.

No documents suggest that the BoC charged fees to issuers of securities that it purchased.

The BAPF did not amend the scheduled maturities of assets it purchased.

Documents do not indicate other conditions beyond those discussed elsewhere in this case study.

No documents suggest that banks received relief from capital or liquidity regulations as a result of participating in the BAPF.

The Canadian BA market was not mirrored abroad, and programs similar to the BAPF were not implemented in other countries.

The BoC purchased its last BAs in the sixth auction, conducted on April 27, 2020. The BoC continued to offer weekly BAPF auctions until July 6, when it reduced the frequency of BAPF auctions from every week to every other week. The BoC cited “substantial improvements in short-term funding conditions recently, as well as reduced participation” when making this change (BoC 2020i).

After 17 operations without participation, the BoC announced on October 15, 2020 that it would retire the BAPF amid continuing improvement of financial conditions, and the declining usage in crisis facilities (BoC 2020a; BoC 2020j). Its last operation—also not used—occurred on October 26, 2020.