DETAILS: Fed’s Secondary Market Corporate Credit Facility Reveals the Start of Buying ETFs
Posted on 05/13/2020
The U.S. Department of the Treasury has made US$ 37.5 billion of the US$ 75 billion equity investment it will make in the special purpose vehicle established by the Federal Reserve for Secondary Market Corporate Credit Facility (SMCCF) and Primary Market Corporate Credit Facility (PMCCF). The Federal Reserve Bank of New York announced that the SMCCF will begin purchases of exchange-traded funds (ETFs) on May 12, 2020.
Secondary Market Corporate Credit Facility (SMCCF)
SMCCF was established to support credit to large employers by providing liquidity for outstanding corporate bonds. The SMCCF may purchase in the secondary market eligible corporate bonds as well as U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. corporate bonds. Each institution from which the SMCCF purchases securities must be a business that is created or organized in the United States or under the laws of the United States with significant U.S. operations and a majority of U.S.-based employees. The institution also must satisfy the conflict of interest requirements of section 4019 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). These institutions are collectively referred to as Eligible Sellers. In order to qualify to become a Seller, these certifications are in order to qualify as such. The seller must make certification regarding its solvency. The seller must certify that it satisfies the conflict of interest requirements in section 4019 of the CARES Act. The seller must certify that it is a business that is created or organized in the United States or under the laws of the United States and that has significant operations in and a majority of its employees based in the United States, consistent with section 4003(c)(3)(C) of the CARES Act.
According to the FRBNY, “As specified in the term sheet, the SMCCF may purchase U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. corporate bonds. The preponderance of ETF holdings will be of ETFs whose primary investment objective is exposure to U.S. investment-grade corporate bonds, and the remainder will be in ETFs whose primary investment objective is exposure to U.S. high-yield corporate bonds. The SMCCF will consider several additional factors in determining which ETFs will be eligible for purchase. Those considerations include: the composition of investment-grade and non-investment-grade rated debt, the management style, the amount of debt held in depository institutions, the average tenor of underlying debt, the total assets under management, the average daily trading volume, and leverage, if any.
To expedite implementation, the SMCCF will begin by transacting with Primary Dealers that meet the Eligible Seller criteria and that have completed the Seller Certification Materials. Additional counterparties will be included as Eligible Sellers under the SMCCF, subject to adequate due diligence and compliance work.
The Primary Market Corporate Credit Facility (PMCCF) is expected to become operational and the SMCCF is expected to begin purchasing eligible corporate bonds in the near future, as detailed previously. More information on SMCCF and PMCCF eligible corporate bond purchases is forthcoming, including specific start dates, issuer certification requirements and more detailed instructions, more details on pricing, among other operational details.”
BlackRock Investment Management Agreement Details with SMCCF
On May 11, 2020, an investment management agreement was signed between BlackRock Financial Management, Inc. and Corporate Credit Facilities LLC, a Delaware limited liability company, regarding the management of the SMCCF. The Federal Reserve Bank of New York formed Corporate Credit Facilities LLC for the purposes of implementing SMCCF. Corporate Credit Facilities LLC plans to purchase in the secondary market eligible corporate bonds issued by U.S. companies and eligible U.S.-listed exchange traded funds. State Street Bank and Trust Company is the custodian of the SMCCF Investment Sub-Account and the SMCCF Cash Reinvestment Sub-Account. FRBNY also serves as the managing member of Corporate Credit Facilities. The agreement is good for three months and is subject to monthly renewals. The FRBNY has worked with both BlackRock and State Street on its Maiden Lane LLC holding structure in relation to the Bear Stearns/JPMorgan deal back in 2008.
The FRBNY is keen on not intervening in company management matters. FRBNY, even if it has a proxy voting right in an eligible investment, BlackRock cannot exercise any such proxy voting right. BlackRock shall not exercise the Corporate Credit Facilities’ power to exercise rights, options, warrants, conversion privileges, and redemption privileges, or its right to tender securities pursuant to a tender offer except as the FRBNY directs in an Instruction. In addition, FRBNY does not want BlackRock to file class action claim forms or otherwise exercise any rights the Corporate Credit Facilities may have with respect to participating in, commencing, or defending suits or legal proceedings involving securities or issuers of securities held, or formerly held, on behalf of the Corporate Credit Facilities, unless BlackRock and the FRBNY mutually agree in writing that BlackRock takes any such actions.
FRBNY also is prohibiting BlackRock from delegating asset or portfolio management duties in relation to the IM agreement.
In addition, BlackRock may select as an intermediary any brokerage firm that (i) is not a BlackRock affilaite and (ii) for any purchase of Eligible Bonds and Eligible ETFs, that is also an Eligible Seller.
Investment Strategy SMCCF
Outline in ANNEX A between the IM agreement between the FRBNY and BlackRock that was signed on May 11, 2020, “The Facility is designed to achieve three objectives: (1) to provide broad support for secondary credit markets to facilitate orderly repositioning and pricing of risk; (2) to support primary issuance for issuers at funding costs that reflect more normalized liquidity and market functioning; and (3) to reduce the incidence and severity of market dysfunction, fire sales or indiscriminate liquidation.
The Facility will operate in three phases: (1) stabilization, (2) ongoing monitoring, and (3) reduction in support. Within each of the stabilization and ongoing monitoring phases, the pace of purchases will be established (and amended periodically) by the Company as a range of percentages of average daily volume in the relevant market, and will be tied to an array of measures of market functioning, the rate of change of such measures, as well as broader market health and macroeconomic indicators.1 The measures will include indicators of market functioning (such as transaction cost estimates, bid-ask spreads, credit curve shape, spread levels and volatility, volumes, and inventories), ETF-specific measures (such as premium/discount to net asset value (“NAV”) and creation/redemption volumes), and the results of Facility and PMCCF operations (such as operational execution metrics for the Facility, the demand in the PMCCF, and PMCCF share of new issuance). Qualitative market color will also be considered. The Manager will determine the specific securities eligible for purchase based on instructions provided by the Company.
Purchases will be directed by the Company, and will be made on a broad basis or, at times, be concentrated in liquidity-challenged ratings or tenors. This may result in short-run concentrations, but over time, purchases will generally take place across the universe of Eligible Issuers in proportion to the amount of their outstanding Eligible Bonds. There may also be short-run concentrations in individual Eligible ETFs, but over time, the preponderance of Eligible ETF purchases will be made in a range of Eligible IG ETFs, and the remainder will be in a range of Eligible HY ETFs. The precise calibration of the strategy, including, but not limited to, indicative purchase paces and supporting metrics, may evolve over time, and any changes will be communicated by the Company to the Manager in a timely manner.
1. Stabilization Phase
– The program will begin with purchases of a range of Eligible IG ETFs and Eligible HY ETFs, with the preponderance of purchases in Eligible IG ETFs. Operational readiness to purchase Eligible Bonds is expected to follow shortly after operational readiness to purchase Eligible ETFs.2
– Purchases will be focused on reducing the broad-based deterioration of liquidity seen in March 2020 to levels that correspond more closely to prevailing economic conditions.
– Purchases made in this phase will generally be made at a higher pace than will occur in the ongoing monitoring phase described below, with the goal of pushing market functioning measures back towards levels more closely aligned with levels that would be consistent with
prevailing economic conditions.
2. Ongoing Monitoring Phase
– Once market functioning measures return to levels that are more closely, but not fully, aligned with levels that correspond to prevailing economic conditions, broad-based purchases will continue at a reduced, steady pace to maintain these conditions.
– Purchases of Eligible ETFs should be reduced, and Eligible Bond purchases should continue to broadly match the universe of bonds eligible to be purchased by the Facility.
3. Reduction in Support Phase
In accordance with Section 13(3) of the Federal Reserve Act, Facility will cease purchasing assets by September 30, 2020, unless the Facility is extended by the Board and the UST.
NOTES
1 If signs of improvement in market functioning are observed, purchases should take place towards the lower end of the range of percentages of average daily volume. If signs of deterioration in market functioning are observed, purchases should take place towards the higher end of the range of percentages of average daily volume.
2 Per the Term Sheet, Corporate bonds cannot be purchased in the Facility until Eligible Issuers have completed a certification process. In the interim, ETF purchases can serve as an efficient mechanism to access the corporate bond market, thereby helping the Facility to achieve its objectives.”
Keywords: Federal Reserve System.
