United States: Primary Dealer Credit Facility

On March 17, 2020, the Fed announced that it had authorized the Federal Reserve Bank of New York (FRBNY) to extend collateralized credit to primary dealers for a term of up to 90 days (FRB 2020m). The stated purpose of the PDCF was to support the credit needs of American households and businesses by fostering the functioning of financial markets more generally and to expand the ability of primary dealers to gain access to term funding (FRB 2020i).

Specifically, by allowing primary dealers to borrow against a variety of assets on their balance sheets, the PDCF intended to reduce the costs associated with holding inventory and intermediating transactions between customers (Kargar et al. 2020; FRB 2020b). The Fed expected the PDCF would add liquidity to the market for US Treasuries in particular, as unprecedented sales volumes in March overwhelmed the capacity of dealers to intermediate in that market (FRB 2020b).

The PDCF worked in concert with other backstop facilities designed to provide targeted liquidity to specific financial entities; namely, the Commercial Paper Funding Facility (CPFF), announced several hours before the PDCF, and the Money Market Mutual Fund Liquidity Facility (MMLF), announced on March 18 (Boyarchenko, Kovner, and Shachar 2020; FSB 2020). The Fed also intervened in the dealer-intermediated secondary market for corporate bonds through the Secondary Market Corporate Credit Facility (SMCCF) (FSB 2020; Kargar et al. 2020).

The Federal Reserve Board authorized the PDCF by invoking its authority under Section 13(3) of the Federal Reserve Act (FRB 2020m). Section 13(3) of the Federal Reserve Act permits the Fed, in “unusual and exigent circumstances,” to “discount for any participant in any program or facility with broad-based eligibility” (FRB 2017, Sec. 13(3)(a)). The invocation of Section 13(3) allows the Fed to provide liquidity more broadly than its monetary policy and discount window authorities allow. Under Section 13(3), the Fed could extend collateralized credit to primary dealers (FRB 2020m). The PDCF received the unanimous approval of the five members of the Fed Board of Governors and the treasury secretary^FThe Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required Treasury pre-approval for the establishment of programs like the PDCF; this stipulation did not exist for the GFC-era PDCF (CRS 2020). (FRB 2020m; Mnuchin 2020).

The PDCF was based on counterparty relationships already in place between primary dealers and the New York Fed because of the latter’s role in conducting open market operations (OMOs) (FRBNY, n.d.b).

Pursuant to Section 13(3) of the Federal Reserve Act, the Fed submitted reports to Congress every 30 days including “the [aggregate] value of collateral, the amount of fees and other items of value received; and the expected or final cost to the taxpayer” (FRB 2020e, 29–30). The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) required the Board to publish these reports on its website within seven days of them being submitted to Congress; although the PDCF was not funded by the CARES Act, the Board published the relevant reports anyway (FRB 2020e).

The Government Accountability Office (GAO) published a report examining the Fed’s overall response to the COVID-19 pandemic, as well as two reports on the Fed’s emergency lending facilities. The reports did not include recommendations specific to the PDCF (GAO 2020a).

Reserve Bank Operations and Payment Systems (RBOPS), a division of the Federal Reserve Board that oversees the policies and operations of the Reserve Banks, conducted a three-phase review of Fed facilities (GAO 2020b). In the first phase, RBOPS assisted with the launch of the facility (GAO 2020b). In the second phase, conducted no later than 45 days after the Board authorized the facility, RBOPS focused its oversight of each facility on four areas: (1) compliance, governance, and risk management; (2) credit and collateral; (3) processes and controls; and (4) accounting and reporting (GAO 2020b). The third phase of RBOPS’s review consisted of monitoring the Fed’s facilities (GAO 2020b). RBOPS communicated any control or design gaps it identified, as well as recommendations for remediation, to Reserve Bank management (GAO 2020b). RBOPS identified unspecified gaps in the design of controls for the PDCF (GAO 2020b).

The Federal Reserve Bank of New York (FRBNY) administered the PDCF. FRBNY was uniquely positioned to operate the PDCF because the facility relies on the relationships and infrastructure built for its dealer trading counterparties who assist the FOMC in implementing monetary policy (FRBNY, n.d.b). FRBNY also administered the GFC-era PDCF with operational assistance from the Federal Reserve Banks of Atlanta and Chicago (GAO 2011).

Dealers typically fund themselves in the tri-party repo market which involves a clearing bank that acts as an intermediary and handles the administrative details between the two parties^FFor a full discussion of the tri-party repo market, see Copeland, et al. (2012). For more information on the role clearing banks play in tri-party repo, see Paddrik et al (2021) and Kahn and Olson (2021). (Duffie 2020; Paddrik, Ramírez, and McCormick 2021). For the PDCF, Bank of New York Mellon (BNYM) executed the custody and arrangement of funding on behalf of the New York Fed (FRBNY 2020b). In 2019 BNYM became the predominant clearing bank in the tri-party repo market for US government securities, providing much of the collateral valuation, margining, management services, transaction settlement, and custodial services (Paddrik, Ramírez, and McCormick 2021).

The Fed established the PDCF to provide primary dealers with access to term funding as part of a larger effort to support financial market functioning and the credit needs of US households and businesses more broadly (FRB 2020m). Throughout the duration of the facility, the Fed reiterated the role of the PDCF in helping dealers resume their market intermediation and smooth market functioning (Martin and McLaughlin 2020; FRB 2020k; FRB 2020l).

Similarly, the Fed created the 2008 PDCF to provide liquidity to primary dealers when troubles at Bear Stearns negatively affected the market for triparty repurchase agreements (Yang 2020; Martin and McLaughlin 2020).

The Fed made regular press releases accompanying decisions on the terms and rules related to the PDCF.

Section 13(3), as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), requires the Fed to present Congress with two types of reports: 1) one submitted within a week after authorizing any loan, providing the justification for the exercise and detailed information on the recipients and the amounts of each transaction; 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 2017). In compliance with the second type of required report, the Fed provided monthly reports to Congress with details on the PDCF including the aggregate amounts borrowed, interest rate charged, and value of pledged collateral, as well as the overall costs, revenues, and fees (FRB 2020i). These reports included more detailed aggregate data on the PDCF’s outstanding loans than were included in the Fed’s weekly release of its balance sheet data (FRB 2020c).

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) required the Fed to publish monthly reports to the public about programs supported by CARES Act funds within seven days of delivering them to Congress (116th US Congress 2020). Although the PDCF was not supported by CARES Act funds, the Fed released the required congressional PDCF reports to the public anyway (FRB 2020e).

The Fed did not publicly disclose disaggregated details about PDCF transactions, unlike some of the other emergency lending facilities^FSee the Main Street Lending Programs by Kelly (2021) and the Primary Market Corporate Credit Facility and Secondary Market Corporate Credit Facility by Leonard (2021). (FRB 2020f). As allowed in the Dodd-Frank Act, the Fed chair requested a delay in the release of confidential treatment of borrower-identifying information for the PDCF, MMLF, and CPFF to avoid adversely affecting these facilities’ participants (GAO 2020b). The Fed was cognizant of the possibility that market participants would view a firm’s use of these facilities as a sign of liquidity stress, which could cause a run on the institution (GAO 2020b). However, Section 11(s) of the Federal Reserve Act, as amended by the Dodd-Frank Act, requires the Fed to disclose detailed transaction-level data within one year after the termination date of any credit facility; for the PDCF, this deadline was March 31, 2022 (FRB 2020j, 12; FRB, n.d.a, sec. 11[s][2][A]).

The PDCF was not operated through an SPV.

The amount of funding that any primary dealer could borrow under the PDCF was limited only by the amount of margin-adjusted eligible collateral that a primary dealer could present to the clearing bank (FRB 2020n).

Use of the PDCF peaked at $35.6 billion the week of April 15 (FRB 2020q). For context, broker-dealers held about $3.5 trillion in assets in Q4 2019 (FRB 2020b). As of August 2021, primary dealers funded an average of $600 billion in daily trade volume while non-primary dealers funded $71 billion (Paddrik, Ramírez, and McCormick 2021).

The PDCF functioned as a loan facility for primary dealers, similar to the way the Federal Reserve’s discount window provides a backup source of funding to depository institutions. Credit extended by the Federal Reserve through the PDCF was collateralized (FRBNY 2020c).

The Fed recorded PDCF loans as assets on its balance sheet (Hoops and Kurtzman 2021). As dealers paid back loans, the Fed extinguished the reserves (FRB 2020c).

The PDCF utilized the New York Fed’s existing operational relationships with primary dealers and the tri-party repo system that is used for OMOs. Primary dealers are trading counterparties of the New York Fed in its implementation of monetary policy. The PDCF extended 356 individual loans to 21 primary dealers (see Figure 5) (FRB 2022).

Securities dealers play a critical role in short-term markets by marketing, underwriting, and transacting in a range of securities; using their balance sheets to make markets; and providing liquidity by buying and selling securities from their own holdings (FRB 2020b). Large dealers, most of whom are subsidiaries of bank holding companies,^FBecause dealer subsidiaries are just one business line to which large banks allocate capital, liquidity, and risk, dealers were further constrained in March 2020 by demands to hold greater margin collateral, loan requests from bank customers, and requests for heightened levels of intermediation in other assets (Duffie 2020). use short-term secured funding markets to fund their inventory of securities^FDealers also source funding from banks and other dealers (FRB 2020b). (FRB 2020b). Primary dealers are heavily reliant on short-term lending markets in their role as securities market makers, but, unlike banks, cannot access the discount window (FRBNY 2020b).

Use of the GFC-era PDCF was restricted to the 20 primary dealers at the time, but included the London-based affiliates of four primary dealers. Ultimately, 18 primary dealers tapped the 2008 PDCF (Yang 2020).

The PDCF was a standing facility (FRB 2020j). Under the PDCF, dealers contacted BNYM with their funding needs, normally by 2:00pm ET, and BNYM would verify that eligible collateral had been pledged. BNYM then notified FRBNY when a sufficient amount of eligible, margin-adjusted collateral had been assigned to FRBNY’s tri-party account, at which point FRBNY transferred the amount of the loan to BNYM for credit to the primary dealer, normally around 5:00pm ET on the same day (FRB 2020n).

The extension of credit under the PDCF depended on the New York Fed’s relationships and processes established as part of the primary dealer system. To mitigate risk, the Fed applied haircuts and had a clearing bank value the collateral at the least available value and revalue it daily (FRBNY 2020b). Loans to primary dealers under the PDCF were made “with recourse beyond the collateral to the broker-dealer entity itself,” assuring the Fed’s protection in the event of a borrower default (FRBNY 2020b). Dealers were permitted to prepay PDCF loans (FRBNY 2020b).

The PDCF accepted all collateral eligible for OMOs: US Treasury, agency, and agency mortgage-backed securities (FRBNY 2020b). The PDCF also accepted non-OMO-eligible collateral, including equity securities, money market instruments, and investment-grade municipal and corporate securities (see Figures 6 and 7) (FRBNY 2020c).

Source: FRB 2022.

In March 2020, high demand for liquidity and unusual selling pressure caused dislocations in the US Treasuries market, which is critical to overall financial market functioning and the transmission of monetary policy (TIC 2021; He, Nagel, and Song 2020; Brainard 2018). Primary dealers also act as market markers for other fixed-income securities, equity securities, and other securities in markets that experienced dislocations. The terms of the PDCF were designed to accommodate this variety, accepting investment-grade corporate debt securities, international agency securities, commercial paper, municipal securities, mortgage-backed securities, asset-backed securities, and equity securities (excluding ETFs, unit investment trusts, mutual funds, rights, and warrants) (FRBNY 2020c). Only US-dollar denominated collateral was accepted (FRB 2020n). Unlike the discount window, the PDCF accepted equity securities as collateral for loans and did not accept foreign-exchange denominated assets or whole loans (FRBNY 2020b; FRB 2021b). In addition, credit under the PDCF was extended in the form of a repurchase agreement transaction (FRBNY 2020b).

Figure 7: Securities Ratings

Source: FRB 2022.

Obligations issued by the borrower or its affiliates were not eligible (FRBNY 2020b). Most of the assets financed in the PDCF were experiencing volatility and pressure in March 2020, including corporate and municipal debt, asset-backed securities, and commercial paper (Martin and McLaughlin 2020).

The 2008 PDCF defined “eligible collateral” as all collateral eligible for pledge under tri-party repurchase agreements. As a result, the 2008 program included some noninvestment-grade securities and whole loans that the 2020 PDCF did not accept (Yang 2020).

FRBNY extended a principal amount equal to the value of the collateral pledged to secure the advance less a risk-adjusted haircut; there were no other restrictions on primary dealers’ use of the facility (FRB 2020j). In the event collateral was downgraded, the primary dealer would need to replace the security with eligible collateral to maintain full collateralization or terminate the loan (FRBNY 2020b).

Haircuts assigned to OMO-eligible collateral were equivalent to haircuts under open market operations (FRBNY 2020c). For collateral not eligible for OMO, haircuts were assigned according to the asset’s risk (FRBNY 2020c). BNYM valued the collateral according to a collateral schedule sent from FRBNY to primary dealers and BNYM (see Appendix); this was designed to be similar to the margin schedule for lending to commercial banks at the discount window^FFor most eligible collateral, the haircut applied at the PDCF aligns to the haircut applied to the longest-dated tenor of that collateral type at the discount window (FRB 2021b; FRBNY 2020c). (FRB 2020n). The Fed stated that the collateral schedule could be adjusted “as conditions warrant and upon further analysis” (FRBNY 2020b).

The 2008 PDCF also assigned haircuts to OMO-eligible collateral that were equivalent to haircuts under the OMOs. Haircuts for non-OMO eligible collateral were determined by the asset’s risk and generally higher than under OMO standards (Yang 2020).

The interest rate for the loan was based on the primary credit (discount window) rate offered to depository institutions at the time the loan was originated. On March 15, the Fed announced it would lower the primary credit rate by 50 basis points to 25 basis points (the upper bound of the federal funds rate). Reducing the spread between the primary credit rate and the general level of overnight interest rates was intended “to help encourage more active use of the window by depository institutions to meet unexpected funding needs” (FRB 2020o; FRB 2020a). From the facility’s launch in March 2020 to its expiration a year later, the primary credit rate remained at 25 basis points (FRB 2020n).

Under normal conditions, the primary credit rate exceeds the overnight repo rate for most eligible securities (FRBNY, n.d.a). As a result, the PDCF was not an especially attractive means of financing an inventory of securities in normal market conditions (GAO 2020b). The Fed set the rate for the PDCF according to the principles of penalty rates in Regulation A^FThe 2015 amendment to Regulation A calls for the Fed to charge a “penalty rate” on all lending through 13(3) emergency lending facilities (FRB 2015).; namely, that the rate “is a premium to the market rate in normal circumstances” but “affords liquidity in unusual and exigent circumstances” (FRB 2015; 12 CFR, n.d.; GAO 2020b, 12; COC 2020, 33). Fed officials told the Government Accountability Office that charging such a rate ensured “the facilities would experience limited participation when credit is available in the marketplace and increased participation when markets declined and there was a shortage of credit” (GAO 2020b, 12). The PDCF was designed to be self-liquidating, meaning dealers were incentivized to use the PDCF only as a backstop, not as a primary funding source once markets returned to normal (GAO 2020b).

The GFC-era PDCF also charged the primary credit rate; throughout the duration of the facility this represented a 25 basis point premium to the upper limit of the fed funds rate (Yang 2020, 13).

The PDCF did not charge borrowers a frequency-based fee, but primary dealers did pay normal tri-party fees to BNYM (FRBNY 2020b).

In contrast, the GFC-era PDCF charged a frequency-based penalty fee on primary dealers that accessed the facility on more than 30 days out of any 120 days. The fee was later revised based on use of the facility for more than 45 business days out of the preceding 180 business days (Yang 2020).

The PDCF offered credit for up to a 90-day term. This brought the facility’s terms in line with changes to the discount window, which, as of March 15, 2020, also allowed depository institutions to obtain secured liquidity for up to 90 days (FRBNY 2020b; FRB 2020a). The median term of the borrowing of the COVID-era PDCF was 14 days, and most borrowing was longer than overnight (see Figure 8) (FRB 2022; Martin and McLaughlin 2020). As the remaining maturity of the loan declined, the primary dealer could choose to prepay the loan and request a new loan up to 90 days (FRBNY 2020b).

The GFC-era PDCF only offered overnight loans (Yang 2020).

Figure 8: Duration of PDCF Loans by Origination Date

Source: FRB 2022.

There were no other restrictions on PDCF participants.

Although the Fed and other financial regulators provided relief from regulation around this time, no regulatory changes were made to specifically accommodate participants in the PDCF.

The Fed did not coordinate with other jurisdictions when designing or operating the PDCF.

The PDCF began extending credit on March 20, 2020, and was designed to continue for “at least six months, or longer if conditions warrant” (FRBNY 2020b). On July 28, the Fed announced that it would extend several 13(3) emergency lending facilities, including the PDCF, through December 31, 2020 (FRB 2020k). On November 30, the Fed announced a further extension of the PDCF to March 31, 2021, along with three other 13(3) programs: the Commercial Paper Funding Facility (CPFF), the Money Market Mutual Fund Liquidity Facility (MMLF), and the Paycheck Protection Program Liquidity Facility (PPPLF) (FRB 2020l). When announcing both extensions, the Fed acknowledged that “financial markets have stabilized significantly,” but pointed to “the presence and extent of volatility and illiquidity in financial markets” and “the price and availability of credit in the market . . . as compared to normal market conditions” as justification for their continued operations (FRB 2020d; FRB 2020g).

The PDCF, along with the CPFF and MMLF, expired on March 31, 2021, while the Fed continued to invoke its 13(3) authorities to operate the PPPLF. All loans made by FRBNY through the PDCF were repaid by April 30, 2021 (FRB 2021a).