US Fed modifies LCR to assist liquidity facilities
14 May 2020 New York
Image: Billion Photos/Shutterstock.com
The US Federal Reserve has temporarily tweaked the liquidity coverage ratio (LCR) by implementing an ‘interim final rule’ aimed at further incentivising participation in its liquidity facilities.
As part of the US central bank’s package of measures to calm markets during the worst of the recent COVID-19 driven volatility, the Fed established the Money Market Mutual Fund Liquidity Facility (MMLF) and the Paycheck Protection Program Liquidity Facility (PPPLF) to push much-needed cash to Wall Street and on to Main Street.
However, these efforts have partly been stymied by the LCR, which requires large banks to hold a buffer of high-quality liquid assets so that they can meet their liquidity needs over a 30-day stress period.
Part of the issue relates to the fact that the LCR has inadvertently created some barriers to firms offering sufficient liquidity to one another, most notably during quarter-ends.
To remedy this, the Fed has introduced the interim final rule to facilitate participation in these facilities by neutralising the LCR impact associated with the non-recourse funding provided by these facilities.
The rule does not otherwise alter the LCR or its calibration.
The rule came into effect on 5 May and will stand for 30 days from then.
In explaining its rationale for introducing the interim rule, the Fed says that until now the LCR meant firms would be required to recognise outflows for MMLF and PPPLF loans with a remaining maturity of 30 days or less and inflows for certain assets securing the MMLF and PPPLF loans.
As a result, a firm’s participation in the MMLF or PPPLF could affect its total net cash outflows, which the Fed says “could potentially result in an inconsistent, unpredictable, and more volatile calculation of LCR requirements across covered companies”.
In addition, the LCR rule assigns inflow rates to collateral generally based on the asset and counterparty type. As a result of the applicable inflow and outflow rates in the LCR rule, MMLF and PPPLF transactions could receive a non-neutral liquidity risk treatment.
Moreover, after these loans are extended and upon their maturity, the associated inflows and outflows could unnecessarily contribute to volatility in LCRs.
Into the weeds
Specifically, the interim final rule adds a new definition to § __.3 and a new § __.34 to the LCR rule.
In § __.3, the new definition ‘Covered Federal Reserve Facility Funding’ means a non-recourse loan that is extended as part of the MMLF and the PPPLF.
The new § __.34 requires Covered Federal Reserve Facility Funding and the assets securing such funding to be excluded from the calculation of a covered company’s total net cash outflow amount as calculated under § __.30 of the LCR rule, notwithstanding any other section of the LCR rule.
This serves to neutralise the effect of the use of the facilities on a firm’s LCR for the duration of the facility.
The full terms of the interim rule can be read here.
As part of the US central bank’s package of measures to calm markets during the worst of the recent COVID-19 driven volatility, the Fed established the Money Market Mutual Fund Liquidity Facility (MMLF) and the Paycheck Protection Program Liquidity Facility (PPPLF) to push much-needed cash to Wall Street and on to Main Street.
However, these efforts have partly been stymied by the LCR, which requires large banks to hold a buffer of high-quality liquid assets so that they can meet their liquidity needs over a 30-day stress period.
Part of the issue relates to the fact that the LCR has inadvertently created some barriers to firms offering sufficient liquidity to one another, most notably during quarter-ends.
To remedy this, the Fed has introduced the interim final rule to facilitate participation in these facilities by neutralising the LCR impact associated with the non-recourse funding provided by these facilities.
The rule does not otherwise alter the LCR or its calibration.
The rule came into effect on 5 May and will stand for 30 days from then.
In explaining its rationale for introducing the interim rule, the Fed says that until now the LCR meant firms would be required to recognise outflows for MMLF and PPPLF loans with a remaining maturity of 30 days or less and inflows for certain assets securing the MMLF and PPPLF loans.
As a result, a firm’s participation in the MMLF or PPPLF could affect its total net cash outflows, which the Fed says “could potentially result in an inconsistent, unpredictable, and more volatile calculation of LCR requirements across covered companies”.
In addition, the LCR rule assigns inflow rates to collateral generally based on the asset and counterparty type. As a result of the applicable inflow and outflow rates in the LCR rule, MMLF and PPPLF transactions could receive a non-neutral liquidity risk treatment.
Moreover, after these loans are extended and upon their maturity, the associated inflows and outflows could unnecessarily contribute to volatility in LCRs.
Into the weeds
Specifically, the interim final rule adds a new definition to § __.3 and a new § __.34 to the LCR rule.
In § __.3, the new definition ‘Covered Federal Reserve Facility Funding’ means a non-recourse loan that is extended as part of the MMLF and the PPPLF.
The new § __.34 requires Covered Federal Reserve Facility Funding and the assets securing such funding to be excluded from the calculation of a covered company’s total net cash outflow amount as calculated under § __.30 of the LCR rule, notwithstanding any other section of the LCR rule.
This serves to neutralise the effect of the use of the facilities on a firm’s LCR for the duration of the facility.
The full terms of the interim rule can be read here.
NO FEE, NO RISK
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
100% ON RETURNS If you invest in only one securities finance news source this year, make sure it is your free subscription to Securities Finance Times
