On Friday, the Federal Reserve released three final rules (previously released as interim final rules) to further ease the continuing liquidity and credit pressures facing financial institutions. Two of these rules pertain to the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF) and the third rule pertains to the ability of member banks to provide liquidity to affiliates for transactions that would otherwise be financed through tri-party repurchase contracts (Repos).
The Federal Reserve created the AMLF last September in order to “extend loans to banking organizations to finance their purchases of high-quality asset-backed commercial paper from money market mutual funds.” The AMLF was initially scheduled to terminate on January 31, 2009; however, the Federal Reserve last December extended the AMLF’s termination date to April 30, 2009.
The rules adopted by the Federal Reserve on Friday in connection with the AMLF were originally adopted as interim final rules in September 2008 and consist of the following:
- Risk-Based Capital and Leverage Capital Guidelines: The rule as adopted “provides a temporary limited exception from the Board’s leveraged and risk-based capital rules for bank holding companies and statement member banks,” that participate in transaction under the AMLF. Ordinarily, a bank would be required to hold capital against asset-backed commercial paper purchased from an affiliated money market fund. The final rule, however, eliminates any capital charge for purchases financed by the Federal Reserve Bank of Boston under the AMLF. This change is designed to encourage participation in the AMLF and appears to be justified on the theory that the bulk of the credit risk is borne by the Federal Reserve Bank of Boston.
- Exemptions for certain purchases of asset-backed commercial paper by a member bank of an affiliate: The rule as adopted provides “regulatory exemptions for member banks from certain provisions of sections 23A and 23B of the Federal Reserve Act and the Board’s regulation W.” These exemptions seek to increase the ability of a member bank to purchase asset-backed commercial paper from an affiliated money market fund pursuant to AMLF. The 23A exemption is reasonably straightforward: in the absence of such an exemption, a bank would be severely limited in the amount of asset-backed commercial paper it could purchase from an affiliated money market fund, and such a limitation would diminish the effectiveness of the AMLF. More interesting – particularly in light of current discussions about purchases by the federal government of troubled assets – is the 23B exemption. 23B requires a bank to purchase assets from an affiliate at market prices. The lifting of this requirement enables a bank to purchase asset-backed commercial paper at prices higher than those currently prevailing.
The Federal Reserve adopted a third final rule easing affiliated-party restrictions for member banks financing Repos with affiliated parties such as broker dealers. The rule “provides a temporary exception to the limitations in section 23A of the Federal Reserve Act, allowing all insured depository institutions to provide liquidity to their affiliate for assets typically funded in the tri-party repo market.” The rule, which was adopted as interim final on September 14, 2008, will expire on October 30, 2009, although the Federal Reserve retains the authority to grant a further extension. As with the 23A exemption above for purchases of asset-backed commercial paper, this exemption for Repos allows a bank to purchase Repos through a tri-party arrangement free from compliance with the stringent limits in 23A on any asset purchases that benefit an affiliate.