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May 19, 2020

US Broker-Dealer Liquidity in the Time of Financial Crisis

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US BROKER-DEALER LIQUIDITY IN THE TIME OF FINANCIAL CRISIS

As the financial markets react to the COVID-19 pandemic,[1] broker-dealers are increasingly looking for mechanisms to increase liquidity. Complicating matters is the fact that broker-dealers seeking liquidity must comply with regulatory capital obligations which differ from those under Generally Accepted Accounting Principles (GAAP). Most importantly for the purpose of this note, obligations to such lenders must be subordinated to the claims of creditors and customers in order for the borrowed funds to count toward a broker-dealer’s asset base for regulatory capital purposes. Broker-dealers may obtain liquidity by receiving these subordinated loans and notes collateralized by securities or by entering into repurchase agreements. U.S. Broker-dealers may also consider taking advantage of the numerous forms of relief offered by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act and the U.S. Federal Reserve Board (the Fed). Each of these options is considered in turn below.

The following note outlines liquidity options as follows:

  • Section 1.1 provides an overview of subordinated loans;
  • Section 1.2 discusses capital injections from parent companies;
  • Section 1.3 discusses repurchase agreements;
  • Section 1.4 summarizes Small Business Administration (SBA) relief programs offered by the CARES Act;
    • Section 1.4.1 provides an overview and discusses eligibility for the Paycheck Protection Program;
    • Section 1.4.2 discusses net capital treatment for broker-dealers utilizing the Paycheck Protection Program;
    • Section 1.4.3 highlights considerations for broker-dealers utilizing Small Business Administration Economic Injury Disaster Loans;
  • Section 1.5 highlights the federal funding facilities that broker-dealers may access in light of the COVID-19 pandemic;
    • Section 1.5.1 summarizes the Main Street Facilities;
    • Section 1.5.2 summarizes the Primary Market Corporate Credit Facility;
    • Section 1.5.3 summarizes the Secondary Market Corporate Credit Facility;
    • Section 1.5.4 summarizes the Term Asset-Backed Securities Loan Facility; and
    • Section 1.5.5 summarizes the Money Market Mutual Fund Liquidity Facility.

I. Overview of Liquidity Options

1.1 Subordinated Loan

SEC Rule 15c3-1 allows for good regulatory capital treatment of the proceeds of any loan subordinated to the claims of creditors or customers and obtained in accordance with the required terms of a satisfactory loan agreement.[2] The required terms are set forth in Appendix D to Rule 15c3-1. FINRA Rule 4110, which governs satisfactory subordination agreements, provides that subordinated loans or notes collateralized by securities must meet “such standards as FINRA may require to ensure the continued financial stability and operational capability” of the broker-dealer. Accordingly, broker-dealers must submit draft subordination agreements and corresponding documentation to FINRA for approval prior to effectiveness in order for the broker-dealer to receive beneficial regulatory capital treatment. A subordination agreement cannot become effective until FINRA grants this approval.

While broker-dealers may use a different form of agreement, FINRA provides standard forms of agreements, which are briefly summarized in the chart below.[3]

FINRA Form

Subordination Type

SEA Rule 15c3-1(d) Debt-Equity Treatment

SL-31D

Cash Borrowing

Debt

SL-31E

Cash Borrowing

Equity

SL-31T

Cash Borrowing

Temporary Debt

SDN-32D

Secured Demand Note

Debt

SDN-32E

Secured Demand Note

Equity

SDN-32T

Secured Demand Note

Temporary Debt

REV-33R

Revolving Cash Borrowing

Debt


The acceptable maturity provisions and type of acceptable lender vary based on which form a broker-dealer uses.

Receiving FINRA approval is a multi-step process. Broker-dealers should consider initiating the approval process well in advance of the proposed effective date of the agreement as FINRA has a specified time period to review and respond to submitted requests. As a preliminary matter, the broker-dealer must submit the draft agreement and other documents required by FINRA, such as corporate governance documents approving the loan. After FINRA accepts the draft documents, the broker-dealer can then execute the agreement and corresponding documents. Final executed versions of all documents and proof of funding must be submitted to FINRA as well.[4]

To the extent a broker-dealer enters into a non-subordinated loan, this loan will not receive the beneficial net capital treatment that subordinated loans receive. For this reason, non-subordinated loans are not preferable in down-market conditions.

1.2 Capital Injection from Parent

A broker-dealer may also consider a capital injection from its parent company in order to increase liquidity. A broker-dealer considering this option should be aware that the broker-dealer cannot guarantee this capital.

Per FINRA Rule 4110(c)(1)[5], no equity capital of a broker-dealer may be withdrawn for a period of one year from the date the equity capital is contributed, unless otherwise permitted by FINRA. As such, a broker-dealer receiving equity capital from its parent would not be able to repay the parent for a year. However, this does not preclude a broker-dealer from paying out profits earned in the forms of dividends.

1.3 Repurchase Agreements

Broker-dealers may also consider entering into a repurchase agreement to increase liquidity. Repurchase arrangements can be mutually beneficial for all financial institutions engaged in such transactions, especially when markets are on the upswing. Those holding a significant number of securities (e.g., broker-dealers and banks) are able to borrow for less, while entities with spare cash (e.g., money market mutual funds and asset managers) have the opportunity to earn a small return without significant attendant risk as the securities serve as collateral.

Broker-dealers entering into repurchase agreements are subject to a number of regulatory requirements,[6] most notably net capital requirements. To arrive at the proper net capital amount, broker-dealers engaging in repurchase transactions must deduct from net worth the greater amount of the excess of the repurchase agreement deficit[7] computed using a series of tests set forth in the regulation.[8] Those engaging in reverse repurchases are required to take a deduction to net worth in arriving at net capital totaling the full amount by which the contract price of a reverse repurchase exceeds the value of the securities received under the agreement (subject to certain specified reductions to this amount).[9] Additional net capital requirements apply in situations involving United States Treasury securities and transactions with affiliates. Using repurchase agreements to finance broker-dealers is ultimately a complex calculation and a variety of factors should be considered before proceeding with such transactions.

1.4 SBA Programs under the CARES Act Legislation

1.4.1 Paycheck Protection Program: Overview and Eligibility

In late March, Congress passed the CARES Act[10], which established the Paycheck Protection Program (PPP)[11]. The PPP provides loans to (i) businesses with 500 or fewer employees and (ii) businesses that otherwise qualify as a “small business concern” under prior standards set by the Small Business Administration (SBA). Potential borrowers must aggregate their employees, revenue, and net worth with those of their affiliates under the applicable affiliation rules issued by the SBA.[12]

Broker-dealers who are eligible borrowers may apply for a loan under the PPP. The loans can be used for payroll support, including paid sick, medical or family leave, and for costs related to the continuation of group health care benefits during those periods of leave.[13] The loans can also be used for employee salaries, mortgage or rent payments, utilities, or any other qualifying debt obligations.[14] The loans are eligible for forgiveness in an amount (the Forgivable Expense Amount) equal to the sum of eligible costs incurred and the payments made during the eight-week period beginning on the date of the origination of the covered loan (the covered period).[15] The amount of loan forgiveness will be reduced for any employee cuts or reductions in wages.[16]

On April 16, 2020, the PPP’s initial allocation of $349 billion was exhausted. In response, a subsequent stimulus package, the Paycheck Protection Program and Health Care Enhancement Act, was enacted on April 24, 2020, providing an additional $310 billion for the PPP as well as $10 billion for administrative costs and fees. Some public companies and other institutions have been criticized for their receipt of PPP funds, and thus firms considering applying for a PPP loan should consider potential reputational issues associated with their participation in the program.[17] For more on the Paycheck Protection Program, please refer to the following client publications: Coronavirus Aid, Relief, and Economic Security Act (CARES Act): Paycheck Protection Program Summary; CARES Act – The SBA’s Paycheck Protection Program: New FAQs Regarding “Necessity” Certification; CARES Act – The SBA’s Paycheck Protection Program: New FAQ Provides Clarity to “Necessity Certification”.

1.4.2. Broker-Dealer Net Capital Treatment

A broker-dealer that has included a loan received pursuant to the PPP program (a covered loan) as a liability on its balance sheet may add back to net capital the portion of the Forgivable Expense Amount that has been recorded as expenses for costs and payments.[18] The amount added back to net capital cannot be greater than the amount of the balance sheet liability for the covered loan that the firm reasonably expects to be forgiven based on the relevant provisions of the CARES Act and cannot increase net capital by more than the balance sheet liability for the covered loan.[19]

The broker-dealer will be required to create and retain documentation of the basis for the add-back (including a record of the computation of the Forgivable Expense Amount; the costs and payments making up that amount; and an estimate of any limits under the loan forgiveness section of the CARES Act (Section 1106(d)) with the underlying basis for such estimate.[20] The firm must also report the add-back in its FOCUS Report.[21]

If a broker-dealer includes a covered loan as a liability on its balance sheet, it may exclude the covered loan from aggregate indebtedness during the eight-week “covered period” following the origination of the covered loan.[22] Once the covered period ends, the firm can exclude the amount of liability for the covered loan that the firm is allowed to add back to net capital from its aggregate indebtedness.[23] Member firms may include any part of the covered loan excluded from aggregate indebtedness on the firm’s Statement of Financial Condition in its FOCUS Report Part II in Item 1380 (Other—Accounts payable and accrued liabilities and expenses) or in Item 1385 (Accounts payable, accrued liabilities, expenses and other) in its FOCUS Report Part IIA.[24]

1.4.3 SBA Economic Injury Disaster Loans

SBA Economic Injury Disaster Loans (EIDL) provide up to $2 million for small businesses suffering substantial economic injury from a disaster, which includes the COVID-19 pandemic.[25] The current interest rate for small businesses is 3.75% with a maximum term of 30 years.[26] These loans may be used to pay fixed debts, payroll, accounts payable, and other bills that firms have been unable to pay due to COVID-19.[27] Under the CARES Act, applicants are now eligible for an emergency grant of $10,000 to be used while the EIDL is being processed.[28] The grant does not need to be repaid even if the EIDL is ultimately denied.[29]

As these loans are not covered loans, it is unclear whether these loans qualify for the same treatment as PPP loans for net capital purposes.

1.5 Federal Reserve Facilities

The Fed has announced a number of funding facilities in light of the COVID-19 pandemic. Broker-dealers meeting the specified conditions would be eligible to borrow from the Main Street Facilities (as defined below), and would be eligible to be borrowers from or sellers to other Fed facilities offered pursuant to the Fed’s emergency lending authority under Section 13(3) of the Federal Reserve Act.

Broker-dealers should note that information regarding borrowing under the Fed’s 13(3) authority is made public. For lending facilities that use CARES Act funding, the Fed announced on April 23, 2020, that it would disclose the following information on a monthly basis:

  • Names and details of participants in each facility;
  • Amounts borrowed and interest rate charged; and
  • Overall costs, revenues, and fees for each facility.

This summary highlights some of the means by which broker-dealers may be able participate in the Fed crisis facilities, but for a detailed description of these and other programs, please see our April 12, 2020 client publication, The Fed Moves Beyond the Financial Crisis Playbook for Pandemic Response.

1.5.1 Main Street Facilities

On April 30, 2020, the Fed issued term sheets for three related lending facilities (the Main Street Facilities) to facilitate loans to small and mid-sized businesses. The Main Street Facilities consist of the Main Street New Loan Facility[30] (MSNLF), Main Street Priority Loan Facility (MSPLF)[31] and the Main Street Expanded Loan Facility[32] (MSELF, and together with the MSNLF and MSPLF, the Main Street Facilities). The MSNLF and MSPLF permit broker-dealers to gain an entirely new source of liquidity by applying for direct loans. One of the main differences between the MSNLF and the MSPLF is that borrowers under the MSPLF may have a higher ratio of debt to EBITDA. Under the MSELF, broker-dealers may seek additional liquidity by upsizing a loan that is pre-existing and originated prior to April 8, 2020.

Under the MSNLF and MSELF, the Federal Reserve Bank of Boston (FRB Boston) will establish an SPV that will purchase 95% participations in eligible loans or, in the case of the MSELF, 95% participations in the upsized tranche of the eligible loans from eligible lenders (the eligible lender will retain 5% of the eligible loan). Under the MSPLF, that SPV will purchase 85% participation in eligible loans, while eligible lenders retain 15% of the eligible loan.

A broker-dealer may be an eligible borrower under any of the Main Street Facilities if it meets the specified standards. Eligible borrowers from any Main Street Facility are businesses with up to 15,000 employees or up to $5 billion in 2019 annual revenues. Each eligible borrower must be a business that is created or organized in the United States or under the laws of the United States with significant operations in and a majority of its employees based in the United States. An eligible borrower does not include Ineligible Businesses as defined, which include the types of businesses listed in 13 C.F.R 120.110(b)-(j) and (m)-(s) (most notably, financial businesses primarily engaged in the business of lending, such as banks, finance companies, and factors) and can only participate in one of the Main Street Facilities or the Primary Market Corporate Credit Facility (as described below).

MSNLF loans are secured or unsecured term loans originated after April 24, 2020 and have the following features:

  • Four-year maturity;
  • Principal and interest deferred for one year (unpaid interest to be capitalized);
  • Adjustable rate of LIBOR + 300 basis points;
  • Principal amortization of one-third at the end of the second and third year and at maturity at the end of the fourth year;
  • Minimum loan size of $500,000;
  • Maximum loan size that is the lesser of
    • (i) $25 million or
    • (ii) an amount that, when added to the eligible borrower’s existing outstanding and undrawn available debt, does not exceed four times the Eligible Borrower’s adjusted 2019 earnings before interest, taxes, depreciation, and amortization (EBITDA);
  • The loan is not, at the time of origination or at any time during the term of the eligible loan, contractually subordinated in terms of priority to any of the eligible borrower’s other loans or debt instruments; and
  • Prepayment permitted without penalty.

MSPLF loans are the same as those under the MSNLF as described above, except as to the following features:

  • Principal amortization proceeds at a rate of 15% at the end of the second and third year with a balloon payment of 70% at maturity at the end of the fourth year;
  • Maximum loan size is the lesser of (i) $25 million or (ii) an amount that, when added to the Eligible Borrower’s existing outstanding and undrawn available debt, does not exceed six times the Eligible Borrower’s adjusted 2019 EBITDA; and
  • At the time of origination and any time thereafter, the Eligible Loan is senior to or pari passu with other loans or debt instruments (besides mortgage debt).

Under the MSELF, an eligible loan is a secured or unsecured loan or revolving credit facility made by an eligible lender to an eligible borrower that was originated on or before April 24, 2020 with a remaining maturity of at least 18 months. The upsized tranche of the loan awarded under the facility must have the following features:

  • Four-year maturity;
  • Principal and interest deferred for one year (unpaid interest to be capitalized);
  • Adjustable rate of LIBOR + 300 basis points;
  • Minimum loan size of $10 million;
  • Maximum loan size is the lesser of (i) $200 million, (ii) 35% of the eligible borrower’s existing outstanding and undrawn available debt in pari passu with the Eligible Loan and equivalent in terms of secured status or (iii) an amount that, when added to the Eligible Borrower’s existing outstanding and undrawn available debt, does not exceed six times the borrower’s EBITDA;
  • At the time of upsizing and at all times the upsized tranche is outstanding, the Eligible Loan is senior to or pari passu with other loans or debt instruments (besides mortgage debt); and
  • Prepayment permitted without penalty.

The eligible borrower under any Main Street Facility must commit to refrain from using the proceeds of the loan to pay the principal balance of, or pay any interest on, any debt until the eligible loan, or in the case of the MSELF, the upsized tranche of the eligible loan, is repaid in full, unless the debt or interest payment is mandatory and due. However, under the MSPLF, the eligible borrower may, at the time of origination of the eligible loan, refinance existing debt owed by the eligible borrower to a lender that is not the eligible lender. Under any Main Street Facility, the eligible borrower must make certain additional certifications and covenants, most notably that: (i) it will not seek to cancel or reduce any of its committed lines of credit with the eligible lender or any other lender and (ii) it has a reasonable basis to believe that it has the ability to meet its financial obligations and does not expect to file for bankruptcy for at least the 90 days following the origination or upsizing of the loan.

Direct loans to borrowers under the Main Street Facilities (and certain other Section 13(3) facilities) are subject to the compensation, stock buyback, and dividend restrictions in the CARES Act. A chart summarizing the compensation and governance restrictions specifically applicable to direct loans under the CARES Act (including the Main Street Facilities) is detailed in our chart, “Compensation and Governance Restrictions on CARES Act Stimulus Recipients.”

1.5.2 Primary Market Corporate Credit Facility

Under the Primary Market Corporate Credit Facility (PMCCF),[33] the Federal Reserve Bank of New York (FRBNY) will establish an SPV that will purchase corporate bonds as the sole investor in a bond issuance with a four-year maturity and purchase portions (up to 25%) of syndicated loans or bonds at issuance with a four-year maturity. The Fed has announced that it has hired Blackrock to administer both the PMCCF and the SMCCF (as defined below). While broker-dealers do not generally issue corporate bonds and are generally not borrowers in syndicated loans, a parent company that qualifies as an “eligible issuer” as defined below may be able to loan or otherwise provide portions of PMCCF funds to a broker-dealer subsidiary. Broker-dealers may also be able to act as underwriters in transactions involving the PMCCF.

Under the PMCCF, an “eligible issuer” is a business that is created or organized in the United States or under the laws of the United States with significant operations in and a majority of its employees based in the United States. Such issuers must also comply with the conflicts of interest requirements under Section 4019 of the CARES Act and have been rated at least BBB-/Baa3 as of March 22, 2020. Notably, eligible issuer does not include insured depository institutions or depository institution holding companies, as defined by the Dodd-Frank Act, or those entities that received “specific support” pursuant to Section 4003(b)(1)-(3) of the Coronavirus Economic Stabilization Act of 2020 (CESA, Subtitle A of Title IV of the CARES Act) or any subsequent federal legislation. In recently released FAQs, the FRBNY further clarified that an eligible issuer may be a subsidiary of a foreign company provided that (1) the eligible issuer itself is created and organized in the United States and (2) the eligible issuer on a consolidated basis has significant operations in and a majority of its employees based in the United States. Certain tests will be used to determine if there are “significant operations in and a majority of employees based in the United States” depending on whether or not the eligible issuer is a subsidiary whose sole purpose is to issue debt. An eligible issuer in the PMCCF that is a subsidiary of a foreign company must use the proceeds derived from participation in the PMCCF only for the benefit of the eligible issuer, its consolidated U.S. subsidiaries, and other affiliates of the eligible issuer that are U.S. businesses, and not for the benefit of its foreign affiliates.

Eligible issuers may approach the PMCCF to refinance outstanding debt during the period of three months ahead of the maturity date of such outstanding debt. Issuers may additionally approach the PMCCF at any time to issue additional debt, provided their rating remains at BB-/Ba3 or above. The maximum amount of outstanding bonds or loans of an eligible issuer that borrows from the PMCCF may not exceed 130% of the issuer’s maximum outstanding bonds and loans on any day between March 22, 2019 and March 22, 2020. The maximum amount of instruments that the PMCCF and the SMCCF (as discussed below) combined will purchase from any eligible issuer is capped at 1.5% of the combined potential size of the PMCCF and the SMCCF (i.e., $11.25 billion based on a combined maximum facility size of $750 billion). Such limit is calculated at the consolidated top-tier parent level.

The Fed will publicly disclose information regarding the PMCCF during the operation of the facilities. Such disclosures will include information regarding participants, transaction amounts, costs, revenues, and other fees. Balance sheet items related to the SPV and the PMCCF will be reported weekly, on an aggregated basis, on the H.4.1 statistical release titled “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” which is published by the Fed. In addition, the Fed will disclose to Congress information pursuant to section 13(3) of the Federal Reserve Act, the Board’s Regulation A, and the CARES Act.

1.5.3. Secondary Market Corporate Credit Facility

Under the Secondary Market Corporate Credit Facility[34] (SMCCF), the FRBNY will establish an SPV that will purchase eligible individual corporate bonds and eligible exchange-traded funds (ETFs) in the secondary market from eligible sellers. An “eligible individual corporate bond” is a corporate bond that, at the time of the bond purchase by the SMCCF, is issued by an eligible issuer and has a remaining maturity of five years or less. An “eligible ETF” is a U.S.-listed ETF whose investment objective is to provide broad exposure to the market for U.S. corporate bonds.

As with the PMCCF, an “eligible issuer” is a business that is created or organized in the United States or under the laws of the United States with significant operations in and a majority of its employees based in the United States and must have been rated at least BBB-/Baa3 as of March 22, 2020, by a major nationally recognized statistical rating organization. If an issuer is subsequently downgraded, it must be rated at least BB-/Ba3 as of the date on which the SPV makes the purchase. An eligible issuer may not be an insured depository institution or depository institution holding company (as defined in the Dodd-Frank Act), and it must not have received specific support pursuant to 4003(b)(1)-(3) of CESA or any subsequent federal legislation. Eligible issuers must satisfy the conflicts of interest requirements of Section 4019 of the CARES Act. Finally, in recently released FAQs, the FRBNY further clarified that an eligible issuer may be a subsidiary of a foreign company provided that (1) the eligible issuer itself is created and organized in the United States and (2) the eligible issuer on a consolidated basis has significant operations in and a majority of its employees based in the United States. The same tests as under the PMCCF will be used to determine if the “significant operations in and a majority of its employees based in the United States” threshold has been met.

An eligible seller is a business created or organized under U.S. law with significant U.S. operations and a majority of U.S.-based employees (with such terms interpreted subject to certain aforementioned tests). Notably, a U.S. subsidiary or U.S. branch or agency of a foreign bank would meet this definition, provided that it satisfies other specified eligibility criteria. To that end, an eligible seller must also satisfy the conflicts of interest requirements of Section 4019 of the CARES Act. The SMCCF will at first transact with Primary Dealers that meet the eligible seller criteria in order to expedite the implementation of the SMCCF. The Fed will subsequently transact with additional counterparties as eligible sellers under the SMCCF, subject to adequate due diligence and compliance work.

The Fed will require a statement of eligibility from eligible sellers subject to certain requirements and processes for certification. The Fed noted in its May 4, 2020 FAQs that such requirements and processes would be published on the FRBNY’s website, and documentation relating to such certifications is now available on the FRBNY website.[35]

The SMCCF will purchase eligible corporate bonds at fair market value. The SMCCF will not purchase non-USD denominated corporate bond issues of eligible issuers. The SMCCF will avoid purchasing shares of eligible ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio.

FRBNY will publicly disclose information regarding the SMCCF during the operation of the facilities on a monthly basis. Such disclosures will include information regarding participants, transaction amounts, costs, revenues, and other fees. Balance sheet items related to the SPV and the SMCCF will be reported weekly, on an aggregated basis, on the H.4.1 statistical release titled “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” which is published by the Fed.

1.5.4. Term Asset-Backed Securities Loan Facility

The Fed has also restarted the Term-Asset Backed Securities Loan Facility (TALF)[36], initially established in 2008 to respond to the Financial Crisis. Under TALF, the FRBNY will establish a SPV that lends to eligible borrowers on a non-recourse basis, with such lending secured by the specified types of asset-backed securities (ABS) collateral (eligible collateral).

Eligible collateral includes U.S.-dollar denominated cash ABS that have a credit rating in the highest long-term or, if no long-term rating is available, the highest short-term investment-grade rating category, and do not have a credit rating below the highest investment-grade rating category. All or substantially all of the credit exposure underlying the eligible ABS must (1) for newly issued ABS, except for collateralized loan obligations (CLOs), be originated by U.S.-organized entities, (2) for CLOs, have a lead or co-lead arranger that is a U.S.-organized entity, and (3) for all ABS, be U.S. domiciled obligors or with respect to real property located in the U.S. With the exception of commercial mortgage-backed securities, SBA Pool Certificates and Development Company Participation Certificates, eligible ABS must be issued on or after March 23, 2020, in order to qualify as eligible collateral.

Eligible borrowers include businesses (1) created or organized in the United States or under the laws of the United States, (2) having significant operations in and a majority of their employees based in the United States, and (3) maintaining an account relationship with a primary dealer. If a borrower is not an investment fund, it must, on a consolidated basis, have significant operations in and a majority of its employees based in the U.S. The Fed will not consider parents or affiliates under this test. A U.S. subsidiary or U.S. branch or agency of a foreign bank are considered created or organized in the U.S. or under the laws of the United States for purposes of meeting the U.S. business requirement, but must also satisfy all other relevant criteria. Borrowers with foreign governments as Material Investors (as defined) may not be eligible.

1.5.5. Money Market Mutual Fund Liquidity Facility

On March 23, 2020, the Fed opened the Money Market Mutual Fund Liquidity Facility (MMMLF)[37]. Under the MMMLF, the FRB Boston established an SPV that makes loans available to eligible financial institutions, which include U.S. broker-dealer subsidiaries of U.S. bank holding companies.

Broker-dealers that are eligible borrowers may purchase eligible collateral from money market mutual funds and then pledge the same to the SPV for advances. Eligible collateral includes: (i) U.S. Treasuries and Fully Guaranteed Agencies; (ii) securities issued by U.S. government-sponsored entities; (iii) rated asset-backed commercial paper that is issued by a U.S. issuer; (iv) rated unsecured commercial paper that is issued by a U.S. issuer; (v) rated municipal short-term debt that has a maturity that does not exceed 12 months; and (vi) certain variable rate demand notes.

It is not necessary to have a master account with FRB Boston or any other Federal Reserve Bank in order to borrow under MMMLF. If an eligible financial institution has an account with any Federal Reserve Bank, the loan will settle through the existing account. In addition, eligible financial institutions without a Federal Reserve Bank account may borrow through a correspondent that does have such account. Eligible borrowers may pledge eligible commercial paper bought from proprietary funds under this facility. However, asset purchases are still subject to applicable banking laws, securities laws, and all other applicable laws.

II. Conclusion

Broker-dealers seeking to increase liquidity have numerous options to do so. We would be happy to answer any questions you may have.

Footnotes

[1]   We refer you to our publications regarding the COVID-19 pandemic, available at:  https://www.shearman.com/key-issues/covid-19-resource-center. You may also want to review our notes regarding broker-dealer considerations at: https://brokerdealer.shearman.com/.
[2]  See SEC Rule 15c3-1(c)(2)(ii)), available at https://www.law.cornell.edu/cfr/text/17/240.15c3-1.
[3]  Id.
[4]  Id.
[5]  Id.
[6]  For instance, broker-dealers must comply with bookkeeping requirements under Rule 15c3-1, consumer protection rules pursuant to Rule 15c3-3 respectively and suitability rules under FINRA Rule 2111.
[7]  The repurchase agreement deficit means the difference between the market value of securities subject to the repurchase agreement and the contract price for repurchase of the securities (if less than the market value of the securities). See Rule 15c3-1(c)(2)(F)(1)(ii).
[8]  Rule 15c3-1(c)(2)(F)(3)(i). See also FINRA Notice to Members 87-50, available at: https://www.finra.org/rules-guidance/notices/87-50.
[9]  Rule 15c3-1(c)(2)(F)(2). See also FINRA Notice 87-50, available at: https://www.finra.org/rules-guidance/notices/87-50.
[10]  Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136 (March 27, 2020), available at:  https://www.congress.gov/bill/116th-congress/house-bill/748/text.
[11]  For a summary of key provisions of the CARES Act, please see our publication “Congress Passes Largest Ever Economic Stimulus Package: Key Provisions of CARES Act”, available at: https://www.shearman.com/perspectives/2020/03/congress-passes-largest-ever-economic-stimulus-package-key-provisions-of-cares-act-covid-19.
[12]  There are four tests to determine whether an affiliation exists: affiliation based on ownership (generally a 50% standard based on voting securities, but also considers negative controls); affiliation arising under stock options, convertible securities, and agreements to merge; affiliation based on management (e.g., control person of one entity controls another); and affiliation based on identity of interest.
[13]  Id.
[14]  Id.
[15]  Id.
[16]  Please see our April 7 client publication, Paycheck Protection Program Summary, for details of the reductions.
[17]  See also Department of Treasury, Paycheck Protection Program Loans:  Frequently Asked Questions (FAQs) (last updated April 26, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf.
[18]  FINRA Frequently Asked Questions Related to Regulatory Relief Due to the Coronavirus Pandemic https://www.finra.org/rules-guidance/key-topics/covid-19/faq#cares.
[19]  Id.
[20]  Id
[21]  Id
[22]  Id
[23]  Id
[24]  Id
[25]  SBA to Provide Disaster Assistance Loans for Small Businesses Impacted by Coronavirus (COVID-19), Release No. 20-24 (March 12, 2020) available at: https://www.sba.gov/about-sba/sba-newsroom/press-releases-media-advisories/sba-provide-disaster-assistance-loans-small-businesses-impacted-coronavirus-covid-19.
[26]  Id.
[27]  See Section 7(b)(2) of the Small Business Act (15 U.S.C. 636(b)(2)).
[28]  Supra note 13.
[29]  Id.
[30]  Main Street New Loan Facility Term Sheet (April 30, 2020), available at: https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200430a1.pdf.
[31]  Main Street Priority Loan Facility Term Sheet (April 30, 2020), available at: https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200430a2.pdf.
[32]  Main Street Expanded Loan Facility Term sheet, available at: https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200430a3.pdf. As a note, the terms of all the Main Street Facilities were developed based in part on public comments received in response to term sheets initially issued on April 9.
[33]  Primary Market Corporate Credit Facility Term Sheet (April 9, 2020), available at:  https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200409a5.pdf.
[34]  Secondary Market Corporate Credit Facility term sheet, available at: https://www.federalreserve.gov/monetarypolicy/smccf.htm.
[35]  See Federal Reserve Bank of New York, Secondary Market Corporate Credit Facility Seller Certification Materials (May 5, 2020), https://www.newyorkfed.org/markets/secondary-market-corporate-credit-facility/secondary-market-corporate-credit-facility-seller-certification.

[36] Federal Reserve announces extensive new measures to support the economy (March 23, 2020) available at: https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm
[37]  Federal Reserve Board broadens program of support for the flow of credit to households and businesses by establishing a Money Market Mutual Fund Liquidity Facility (March 18, 2020) available at: https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm. You may also wish to refer to the Money Market Mutual Fund Liquidity Facility FAQs available at: https://www.federalreserve.gov/monetarypolicy/files/mmlf-faqs.pdf.

Special thanks to Andrew Lewis and Caitlin Hutchinson Maddox for their contribution to this publication.  

Authors and Contributors

Russell Sacks

Partner

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Jennifer D. Morton

Partner

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Reena Agrawal Sahni

Partner

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Timothy J. Byrne

Counsel

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Steven Blau

Associate

Financial Institutions Advisory & Financial Regulatory

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Taylor Pugliese

Associate

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