The Fed reinstated its crisis-era commercial paper facility on Tuesday, in a hotly-anticipated move aimed at unfreezing a crucial market before things get really messy and companies start to struggle meeting payroll and funding day-to-day operations.
“The commercial paper market has been under considerable strain in recent days as businesses and households face greater uncertainty in light of the coronavirus outbreak”, the Fed said, in a statement. “By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market”.
Tuesday saw severe dollar-funding stress show up in cross-currency basis, while Libor jumped the most since the crisis. Between that and the sharp widening in commercial paper spreads (see the visual), the COVID-19 panic is morphing into a financial crisis.
The statement goes on to say that Treasury is providing $10 billion of credit protection to the Fed in connection with the new CPFF from the Treasury’s Exchange Stabilization Fund (ESF) – that, incidentally, is the same fund the Trump administration would tap were it to intervene unilaterally in currency markets.
As was the case during the crisis, the Fed will set up an SPV, which will then buy CP, and the loans will be secured by all of the assets of the SPV.
“An announcement about the reintroduction of the facility could be made as early as today”, Reuters said early Tuesday, presaging the move, which multiple desks recommended the Fed make last week. Reuters reiterates why this matters: “The move will allow the Fed to circumvent banks and get liquidity straight to ailing businesses [and] is seen as a key tool as the Fed looks to support smaller firms”.
“The SPV will purchase from eligible issuers three-month USD commercial paper through the New York Fed’s primary dealers”, the Fed said, in a brief explainer that accompanied the announcement. “Eligible issuers are US issuers of commercial paper, including US issuers with a foreign parent company”.
The SPV will buy commercial paper through March 17, 2021, unless the Fed decides to extend the facility. The New York Fed will keep funding the SPV until all of the assets mature.
The original CPFF was announced on October 7, 2008. The associated LLC started making purchases around three weeks later, and was closed on February 1, 2010. It was dissolved on August 30, 2010.
The following visual shows the scope of the purchases made across the time frame when the original, crisis-era facility was operational:
The details released by the Fed on Tuesday are embedded below.
For those who want the granular explanation on what this entailed during the crisis, you can read the full explanation from the Fed, also excerpted below.
Details on new CPFFmonetary20200317a1
Original Commercial Paper Funding Facility (CPFF)
Commercial paper is a critical source of funding for many businesses. In the fall of 2008, the commercial paper market was under considerable strain as money market mutual funds and other investors–themselves often facing liquidity pressures–became increasingly reluctant to purchase commercial paper. As a result, the volume of outstanding commercial paper fell, interest rates on longer-term commercial paper increased significantly, and an increasingly high percentage of outstanding commercial paper needed to be refinanced each day. This restriction in the availability of credit made it more difficult for businesses to obtain credit during a critical period of economic stress.
To address these strains, the Federal Reserve established the Commercial Paper Funding Facility (CPFF) to provide liquidity to U.S. issuers of commercial paper in the event that credit was not available in the market. By providing liquidity to the commercial paper market, the CPFF encouraged investors to resume lending in the market.
Under the program, the Federal Reserve Bank of New York (FRBNY) provided three-month loans to the CPFF LLC, a specially created limited liability company (LLC) that used the funds to purchase commercial paper directly from eligible issuers. The commercial paper that was eligible for purchase was highly rated, U.S. dollar-denominated, unsecured and asset-backed commercial paper with a three-month maturity. To manage its risk, the Federal Reserve required issuers whose commercial paper was purchased by the CPFF LLC to pay fees at the time of each purchase. Additionally, at the time of the initial registration, each issuer was required to pay a facility fee equal to 10 basis points of the maximum amount of commercial paper that it could issue to the CPFF LLC. A total of $849 million in fees were collected by the CPFF LLC. The FRBNY’s loan to the CPFF LLC was secured by all of the LLC’s assets, including its commercial paper holdings, accumulated fees, and proceeds from investments.
The CPFF was created by the Federal Reserve under the authority of Section 13(3) of the Federal Reserve Act, which permitted the Board, in unusual and exigent circumstances, to authorize Reserve Banks to extend credit to individuals, partnerships, and corporations. The facility was administered by the FRBNY.
The facility was announced on October 7, 2008, began purchases of commercial paper on October 27, 2008, and was closed on February 1, 2010. The last of the CPFF LLC’s commercial paper holdings matured on April 26, 2010, and the CPFF LLC was dissolved on August 30, 2010. All loans that were made to the CPFF LLC were repaid in full, in accordance with the terms of the facility, and all of the commercial paper that the CPFF LLC purchased was repaid in accordance with the stated terms.