Fed to Allow Money Market Funds as Reverse Repo Counterparties
I want to thank my colleague Mark Nelson for this excellent piece on a topical issue.
The Federal Reserve Bank of New York has announced that it will expand the set of counterparties it uses for reverse repo transactions to include money market mutual funds. Previously, only entities designated as primary dealers could engage in such transactions with the Fed. The purpose of this change is to ensure the availability of enough counterparties to engage in reverse repo transactions when the Fed begins to withdraw economic stimulus. In October of 2009, the Fed issued an operating policy statement in which it noted that reverse repos were one tool it may use to withdraw economic stimulus. The Fed even conducted tests with prospective counterparties to determine the feasibility of using reverse repos in this manner. The Fed now appears ready to move forward with its preparations to remove accommodative monetary policy, subject to the caution that doing so amounts to "prudent advance planning" and is not intended to imply the timing of any change in monetary policy.
Under the Fed's program, reverse repo transactions would be conducted pursuant to a directive from the Federal Open Market Committee (FOMC) and would be offered to primary dealers and money market mutual funds (MMMFs), conducted through an auction for a fixed rate, settled through the tri-party repo system, and held against collateral from the Fed's System Open Market Account (SOMA). The Fed's announcement also stated that the initial eligibility will be limited to domestic MMMFs who can meaningfully participate in the program. The Fed's transactions with MMMFs will be limited to reverse repos, while existing primary dealers will continue to engage in a broader array of transactions with the Fed. The Fed may include other types of counterparties and allow for expanded eligibility in any future expansion of the program.
To be eligible, a MMMF must demonstrate that it: (i) is an open-end management investment company organized under the laws of one of the United States, (ii) is registered under the Investment Company Act of 1940 and holds itself out as a money market fund under, and is in compliance with, Rule 2a-7, (iii) has net assets of at least $20 billion for six consecutive months (measured at month-end) prior to submitting an application, (iv) has been in existence for at least one year prior to submitting an application, (v) is a consistent investor in the tri-party repo market (including transactions collateralized by U.S. government debt, agency debt, and agency MBS), (vi) is able to confirm and arrange settlement of a significant volume of transactions with the Fed, and (vii) is able to satisfy additional transaction requirements, including the ability to execute transactions with securities margined at 100 percent, execute transactions with terms of up to 65 business days or longer, submit minimum bids of at least $1 billion (a footnote states that a fund family may be allowed to aggregate the bids of its eligible funds, subject to the $1 billion requirement), execute transactions for next day settlement, and execute the required documentation.
In order to participate in the Fed's program, a MMMF must submit an application. Part I of the application covers basic information about the applicant and is due to the Fed by March 19, 2010. The Fed will notify applicants by March 26, 2010 if they have satisfied the eligibility criteria. Successful applicants will have until April 2, 2010 to submit Part II of the application, which covers a detailed description of an applicant's organization and governance, financial condition, regulatory and legal matters, compliance regime, internal controls, shareholder base, and other information. Applicants must further execute an information sharing agreement with the Fed upon request, execute a master repurchase agreement, and execute a tri-party custody agreement. The Fed's announcement noted that it will publish a master repo agreement in about one month.
An applicant also must submit to a review conducted by the Fed. The review to be conducted by the Fed must examine an applicant's compliance with the eligibility requirements and other relevant matters. The review will emphasize prudent counterparty risk management regarding the MMMF's and its investment adviser's financial condition, compliance program, internal controls, and legal or regulatory matters. The Fed may consult with the Securities Exchange Commission (SEC), the relevant self-regulatory organization (SRO), or other regulators. An applicant may be rejected if it poses undue risks to the integrity, reputation, or assets of the Fed. Similarly, an applicant may be rejected if it, or its investment adviser, has been the subject of litigation or regulatory action or investigation during the year prior to its application. The Fed has sole discretion to determine if the matter is material or relevant and may consider the stage of any proceeding and the prospective counterparty's regulatory compliance history. The Fed may drop a MMMF as reverse repo counterparty if the fund does not satisfy the criteria for continued eligibility.
In addition, various provisions of the securities laws and corresponding rules may be implicated by the participation of MMMFs as reverse repo counterparties in the Fed's program. With respect to previous Fed programs to stimulate the economy, the SEC granted no-action relief sought by the Fed, individual funds, and fund industry organizations. As of the time of this blog posting, the SEC had not issued any relevant no-action relief.
Resources
The Fed's (i) Statement Regarding Counterparties for Reverse Repurchase Agreements (March 8, 2010), (ii) RRP Eligibility Criteria for Money Funds (March 8, 2010), and (iii) Application to Become a Reverse Repurchase Agreement Transaction Counterparty (March 8, 2010) may be found at the Federal Reserve Bank of New York's website.
Statement Regarding Reverse Repurchase Agreements (October 19, 2009).
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