United States: Commercial Paper Funding Facility II

On March 17, 2020, the Board of Governors of the Federal Reserve announced that it had authorized the Federal Reserve Bank of New York (FRBNY) to begin purchasing commercial paper (CP) under the CPFF. The purpose of the temporary facility was to enhance liquidity in the CP market by providing a backstop to US issuers and, by extension, reassure investors that firms and municipalities would be able to roll over their maturing CP. The Fed further intended for the liquidity backstop to support the flow of credit to “families, businesses, and jobs across the economy” (FRB 2020f).

The Fed took extensive measures to enable the flow of credit to the economy through programs such as the Primary and Secondary Market Corporate Credit Facilities, the Term Asset-Backed Securities Loan Facility (TALF), the Primary Dealer Credit Facility (PDCF), and the Money Market Mutual Fund Liquidity Facility (MMLF). According to Boyarchenko et al. and the Government Accountability Office (GAO), the Fed designed the CPFF to work “in concert” with the MMLF: While the CPFF helped to reduce strains on money market funds, the MMLF alleviated “fire-sale dynamics” that could have negatively affected CP liquidity (2020, 3; GAO 2020, 28). Both facilities were intended to support state and local governments before the announcement of the $500 billion Municipal Liquidity Facility (MLF) in early April 2020 (Boyarchenko et al. 2021).

The Fed authorized the CPFF by invoking its authority under Section 13(3) of the Federal Reserve Act. Section 13(3) permits the Fed, in “unusual and exigent circumstances,” to “discount for any participant in any program or facility with broad-based eligibility” (FRB 2017). The invocation of Section 13(3) allows the Fed to provide liquidity more broadly than its monetary policy and discount window authorities allow.

As noted in an internal Fed legal memo from 2008, the Fed Board “consistently has viewed the term ‘discount’ under section 13(3) as including a Reserve Bank extension of credit . . . as well as a purchase by a Reserve Bank of third-party notes” (Alvarez et al. 2008). In the case of the CPFF, the Fed was effecting the latter function.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act of 2010) required Treasury pre-approval for the facility’s establishment; this stipulation did not exist for the GFC-era iteration of the CPFF (CRS 2020).

In its October 2021 report, “Credit Markets Served by the Programs Have Stabilized, but Vulnerabilities Remain,” the GAO remarked that credit risks in short-term corporate credit markets had continued to remain low since its previous assessment, in December 2020). The GAO said that since June 2020, the CPFF, the MMLF, and the PDCF had contributed to a decrease in such risks to pre-pandemic levels (GAO 2021).

After completing two phases of its oversight, the Reserve Bank Operations and Payment Systems (RBOPS)—a division of the Federal Reserve Board that reviews the Federal Reserve Banks’ provision of financial services to the financial sector, among other responsibilities—reported that it did not identify any gaps in the design controls of the CPFF (GAO 2020).

Eligible issuers participating in the CPFF were required to sell CP to the SPV through designated CPFF dealers, defined as the FRBNY’s primary dealers and any other dealers that the New York Fed selected. The mechanism for electronic trade execution allowed for a simple processing procedure “requiring little manual intervention” (Boyarchenko et al. 2021). The efficiency of the same-day settlements also assured issuers that the facility could meet any unexpected liquidity shortfalls (Boyarchenko et al. 2021).

The FRBNY required eligible dealers to be highly rated US broker-dealers registered with the SEC and regulated as a member of FINRA. They were also obliged to have held at least $1 million in net regulatory capital and demonstrate an “active and established” business presence in the CP market (FRB 2020a, 1).^F“A firm may demonstrate an ‘active’ business presence by having transacted in the facility’s targeted market segment over the last year, preferably at volumes consistent with or above the prior two years . . . A firm may demonstrate an ‘established’ presence by having been active in the facility’s targeted market segment for at least 3 years” (FRB 2020a, 1). As part of its commitment to supporting equal opportunity and diversity, the FRBNY twice expanded its eligibility criteria for agents and counterparties to address the fair inclusion of women, minorities, and veterans. The press releases, dated September 9 and October 23, 2020, stated that the chosen firms represented a “diverse range of market participants in terms of . . . ownership, including Minority, Women, and Veteran Business Enterprises (MWVBEs)” (FRBNY 2020e, 1). Additionally, the FRBNY mandated all firms submitting expressions of interest in any of the 13(3) facilities to provide details about their efforts to support equal opportunity and diversity within their workforce.

On March 22, 2020, the FRBNY announced that it had appointed Pacific Investment Management Company, LLC (PIMCO) to temporarily act as a third-party investment manager for the facility. The FRBNY chose PIMCO for its experience in the CP markets and credit risk management, particularly its involvement with the GFC-era iteration of the CPFF (FRBNY 2021a).

Additionally, the FRBNY announced on March 25, 2020, that it had commissioned State Street Bank & Trust Company to provisionally serve as a third-party custodian and accounting administrator. The FRBNY selected State Street in part because of its pre-existing relationship with PIMCO (FRBNY 2021a).

The Fed noted by mid-March 2020 that the commercial paper market was under “considerable strain” because of the economic uncertainty surrounding the outbreak of COVID-19 in the US (FRB 2020f, 1). In response, it announced the revival of the CPFF, a GFC-era facility that it hoped would “enhance the ability of businesses to maintain employment and investment” (FRB 2020f, 1). Its communications noted that households and businesses would benefit from its support of the flow of credit.

Pursuant to the modifications specified by the Dodd-Frank Act of 2010, the Fed presented to Congress two types of reports: (1) one submitted within a week of the facility’s establishment that included “information regarding the justification for the exercise of the authority and information on the transactions and expected cost to taxpayers,” and (2) a monthly update “regarding the value of collateral, the amount of fees and other items of value received, and the expected or final cost to the taxpayer” (FRB 2020m, 29; FRBNY 2020b).

The Fed published the latter reports on its website beginning on April 28, 2020, but withheld identifying details because, according to a GAO report, publicly disclosing the information could have “adversely” affected the program’s participants by signaling an entity’s financial distress (FRB 2020i; GAO 2020, 20). However, pursuant to Section 11(s) of the Federal Reserve Act, the Fed disclosed the names and identifying details of each participant in the facility one year following the effective date of termination (FRBNY 2020b; FRB 2022c). 

Additionally, the Fed published annual audited financial statements specific to the SPV, CP Funding Facility II LLC; two have been published as of this writing (FRBNY 2021c; FRBNY 2021d). 

Balance sheet information was also reported weekly, on an aggregated basis, on the Fed’s H.4.1. statistical release, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.”

The Fed has viewed use of the SPV structure as providing management, accounting, and legal advantages to an intervention—especially when the Fed operates multiple Section 13(3) programs in parallel.^FSee also Bernanke, Geithner, and Paulson 2020, 156–158. Use of an SPV allows the Fed to better tailor a 13(3) program to the goals of the intervention (Baxter 2009, 12–13). Each intervention has its own specific terms, timeline, capital structure, and management team. The management teams may also be in geographically separate reserve banks, depending on which is administering a given intervention.

The SPV structure simplifies the reporting of income and the management of any sales of assets discounted by the facility. As noted in Key Design Decision No. 7, Disclosure, the Fed provided separate annual financial statements for the CPFF that were independently audited by an outside accounting firm. These statements provided greater detail and transparency than existed for Fed facilities that did not utilize the SPV structure (Bernanke, Geithner, and Paulson 2020, 157; FRB 2022b). Moreover, the degree of corporate separation from both the Fed and other 13(3) interventions provided by an SPV structure may provide those other entities some protection in the event a 13(3) program is sued.

SPVs are also typically easy and inexpensive to set up. The Fed has viewed its creation of the structures as falling under the “incidental powers as shall be necessary to carry on the business of banking within the limitations” of the Federal Reserve Act (FRB n.d.; Bernanke, Geithner, and Paulson 2020, 156, fn 28).

The FRBNY had full recourse to all of the assets in the SPV, including all fees and earnings generated throughout its operation. Each loan bore interest on the outstanding principal amount equal to the interest rate on excess reserves. As a result, the Fed expected that the program would not result in losses to its own balance sheet or to taxpayers through the Treasury’s equity investment (FRB 2020b).

The maximum amount of CP that a single participant could issue to the CPFF could not exceed the greatest amount of USD-denominated CP that the issuer had outstanding on any day between March 16, 2019, and March 16, 2020. According to FRBNY Staff Economist Nina Boyarchenko, the purpose of the look-back period was to ensure that firms were not borrowing more than they would have under “normal” market conditions.^FAccording to Dr. Boyarchenko, all 2020 facilities used 2019 as a “rule-of-thumb” normal market. This restriction was similar to that of the GFC-era iteration of the CPFF, which based its maximum amounts on issuance between January and August 2008.

For an issuer that on March 17, 2020, was rated at least A1/P1/F1 by a major NRSRO or, if rated by multiple major NRSROs, was rated at least A1/P1/F1 by two or more major NRSROs but was later downgraded, the maximum amount of the issuer’s CP that the CPFF would purchase equaled the amount of US dollar-denominated CP that the issuer had outstanding the day before it was downgraded.

The CPFF would not purchase additional CP from an issuer whose total CP outstanding to all investors (including the SPV) equaled or exceeded the aforementioned limits. Although the FRBNY did not impose any minimum purchase limits, the Bloomberg Professional Boom platform accepted transactions over $100,000. 

Utilization peaked at approximately $4.3 billion in total outstanding CP held by the SPV as of May 14, 2020 (FRB 2020). By contrast, the GFC-era iteration of the CPFF saw usage in the hundreds of billions of dollars, peaking at about $348.2 billion on January 21, 2009 (CRS 2020).

The Fed reported on November 6, 2020, that the total outstanding amount of CP held by the SPV had fallen to zero as of October 31, 2020 (FRB 2020l).

The FRBNY provided loans to the CPFF II LLC at the rate of interest on excess reserves. It fully funded any loans that the SPV extended, which stood at $4.2 billion as of Q2 2020, falling to $30 million as of Q3 2020. The FRBNY’s balance fell to zero and remained there for the rest of the program’s operations (Hoops and Kurtzman 2021). According to the FRBNY, any credit extended during the program was made with full recourse to the SPV and secured by all assets of the SPV (FRBNY 2020b). Treasury also used the Exchange Stabilization Fund to provide a $10 billion equity investment to protect the Fed from losses. The FRBNY committed to funding the SPV until its underlying assets matured.

The CPFF II LLC used the proceeds from maturing commercial paper and other assets of the SPV to repay its loan to the FRBNY (FRBNY 2020b).

As with the GFC-era version of the CPFF, US subsidiaries of foreign parent companies were eligible. On March 23, 2020, the Fed changed the term sheet to explicitly allow municipalities to issue CP for the first time.^FThe term sheet released on March 17, 2020, specified that “eligible issuers are U.S. issuers of commercial paper, which includes municipalities by definition.” This complemented the Fed’s expansion of the MMLF to accept a wider range of municipal instruments for secondary market purchases (Boyarchenko et al. 2021). The Fed decided not to establish a secondary market facility for municipal bonds because, as Senator Pat Toomey and Representative French Hill testified to the Congressional Oversight Commission, it would have taken “much longer” than expanding access to liquidity through the CPFF or the MMLF (COC 2020, 43–44).

The SPV would not purchase CP from issuers that had been inactive prior to the creation of the CPFF. Specifically, an issuer was considered inactive if it had not issued ABCP to institutions—other than the sponsoring institution—for any consecutive three-month period or longer between March 16, 2019, and March 16, 2020.  

The FRBNY required issuers to certify that they were unable to “secure adequate credit accommodations from other banking institutions” (FRBNY 2020b, 2). In order to meet this condition, the borrower could cite the availability, pricing, and terms of credit given prevailing market conditions. Applicants wishing to issue ABCP were also required to have been active prior to the announcement of the CPFF.

Furthermore, applicants had to prove that they were solvent and not participating in the CPFF for the purpose of lending proceeds to a person or entity that was insolvent. This stipulation was not enforced under the terms of the GFC-era version of the CPFF (FRBNY 2009; FRBNY 2020b).  

According to the transaction-specific disclosures released on March 31, 2022, there were only 27 draws on the facility by seven distinct borrowers. Two of those borrowers were domestic, one of which (Cummins) was a nonfinancial institution. Of the $4.2 billion extended, $1.5 billion went to the Industrial Commercial Bank of China (ICBC) (FRB 2022c).

The CPFF II LLC was able to purchase CP or ABCP “at any time while the CPFF [remained] open, subject to applicable limits” (FRBNY 2020b, 4).

Rather than purchasing CP directly, the Fed preferred to lend to an SPV because, as was the case with the GFC-era iteration of the CPFF, it was dealing in an unusual security and with many counterparties it did not normally lend to (Wiggins 2020).

CP was required to be rated at least A1/P1/F1 by a major nationally recognized statistical rating organization (NRSRO) as of March 17, 2020. If rated by multiple major NRSROs, it was required to be rated at least A1/P1/F1 by two or more major NRSROs. If the issuer was subsequently downgraded while participating in the CPFF, it would be able to make a one-time sale of CP to the SPV, as long as the issuer was rated at least A2/P2/F2 by a major NRSRO or, if rated by multiple major NRSROs, was rated at least A2/P2/F2 by two or more major NRSROs. Downgraded issuers were allowed to make a one-time sale to the facility, with the goal of allowing them to roll over maturing CP while seeking alternative funding (Boyarchenko et al. 2021). Although the GFC-era iteration of the CPFF issued the same guidance around multiple ratings, the terms did not include a downgrade provision (Wiggins 2020). 

On March 23, 2020, the Fed expanded eligibility to include tax-exempt CP as eligible securities in order to support credit to municipalities. The updated terms also included a provision wherein an issuer that was subsequently downgraded to A2/P2/F2 could make a single sale of CP to the CPFF (FRB 2020d, 1).

On May 26, 2020, the Federal Reserve expanded the set of nationally recognized statistical rating organizations (NRSROs) whose ratings would be accepted in determining the eligibility of commercial paper—adding DBRS, Inc.; Kroll Bond Rating Agency, Inc.; and only with respect to insurance companies, A.M. Best Rating Services, Inc.—to the extent the issuer also had a qualifying rating from one of the original three NRSROs (Boyarchenko et al. 2021).

The initial terms and conditions, released on March 17, 2020, priced Tier 1 CP (rated A1/P1/F1) based on the three-month OIS rate plus 200 basis points, equivalent to the all-in pricing offered by the GFC-era facility (Boyarchenko et al. 2021).

The FRBNY updated its pricing terms on March 23, 2020. For CP rated A1/P1/F1, pricing was based on the prevailing three-month OIS rate plus 110 bps. Pricing for Tier 2 CP that was rated A2/P2/F2 was based on the then-current three-month OIS rate plus 200 bps. Although this scheme was similar to that used for the GFC-era CPFF, architects of the first version determined pricing guidelines based on whether the CP was secured, rather than the NRSRO rating (FRBNY 2009). The COVID-era rates thus reflected an overall decrease in price (CRS 2020).^FMarkups for the GFC-era CPFF varied from 100 bps to 300 bps over the OIS rate (CRS 2020, 13). Furthermore, Boyarchenko et al. emphasized the importance of pricing assets such that “usage should naturally decline” with normalizing conditions (2021, 10).

Haircuts apply only to programs that involve lending to counterparties.

According to Wall Street Journal reporter Nick Timiraos, Treasury Secretary Mnuchin encouraged the Fed to charge “slightly higher rates” than it had done during the GFC (Timiraos 2022, 167). The agreed-upon penalty rate was thus set at 2 percentage points above an overnight-borrowing benchmark (Timiraos 2022).

As was the case during the GFC, the 10-basis-point facility fee was determined by the maximum amount of an issuer’s commercial paper that the SPV may have owned (FRBNY 2009).

This refers to the loan maturity and applies only to programs that involve lending to counterparties.

Sources consulted do not indicate the imposition of restrictions on CPFF participants.

Sources consulted do not indicate the existence of regulatory concessions.

Sources consulted do not indicate that the Fed consulted with international parties.

On November 30, 2020, the Fed, with approval from the Treasury Secretary, announced an extension through March 31, 2021, for several of its emergency lending facilities. The Fed noted that the continued availability of the programs through the first quarter of 2021 would further “help the economy recover from the COVID-19 pandemic” (FRB 2020h, 1).

The FRBNY terminated the SPV on July 8, 2021, having returned Treasury’s equity contribution and an additional $4.8 million in interest. The SPV also distributed its $49.1 million in profits to the Treasury and the FRBNY (Boyarchenko et al. 2021).