Originally published on May 6, 2020. Last updated as of June 22, 2020.
On June 15, 2020, the Federal Reserve Bank of New York (the “New York Fed”) published an updated set of Frequently Asked Questions (“FAQs”) concerning the Primary Market Corporate Credit Facility (the “PMCCF”) and the Secondary Market Corporate Credit Facility (the “SMCCF,” and together with the PMCCF, the “CCFs”) established under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The New York Fed also published a revised term sheet for the SMCCF, which updates the previous SMCCF term sheet issued on April 9, 2020. Together, these documents clarify various terms of the CCFs, in particular, the strategy for purchasing corporate bonds under the SMCCF.
The PMCCF will serve as a funding backstop for corporate debt issued by eligible issuers and the SMCCF will provide liquidity to the market for outstanding corporate bonds. Purchases will be made under the CCFs until September 30, 2020, unless extended, and the Federal Reserve will continue to fund each facility after such date, until its holdings mature or are sold. The combined size of the CCFs will be up to $750 billion. The PMCCF, initially funded with $50 billion of equity from Treasury, will leverage its equity ten times when acquiring bonds or syndicated loans from investment grade issuers, and seven times when acquiring other eligible assets. The SMCCF, initially funded with $25 billion of equity from Treasury, will leverage its equity ten times when acquiring corporate bonds from investment grade issuers and ETFs whose primary investment objective is exposure to investment grade corporate bonds. It will leverage its equity seven times when acquiring corporate bonds from issuers rated at below investment grade, and from three to seven times when acquiring other eligible assets, depending on risk.
The SMCCF began purchasing ETFs on May 12, 2020 and corporate bonds on June 16, 2020. The PMCCF is expected to launch in the near future, although the New York Fed has not announced specific start dates.
This updated alert describes and analyzes the New York Fed’s updated FAQs and the SMCCF term sheet. For more information on the CCFs generally, see our client alert here.
Selection of Bonds for Purchase by the SMCCF
In its latest FAQs, the New York Fed provided significant additional detail on how bonds will be selected for purchase by the SMCCF.
Pursuant to the SMCCF, the special purpose vehicle that will purchase corporate debt in the secondary market may purchase (i) individual corporate bonds (“Eligible Individual Corporate Bonds”), (ii) corporate bond portfolios in the form of exchange-traded funds (“Eligible ETFs”) and (iii) individual corporate bonds to create a portfolio that tracks a broad, diversified market index of U.S corporate bonds (“Eligible Broad Market Index Bonds”). The SMCCF began purchasing Eligible ETFs on May 12, 2020 and Eligible Broad Market Index Bonds on June 16, 2020. The SMCCF may in the future purchase Eligible Individual Corporate Bonds using other selection methodologies.
The broad market index, developed specifically for the SMCCF (the “Broad Market Index”), generally tracks the composition of the universe of secondary market bonds that meet the criteria for Eligible Broad Market Index Bonds. To be included in the Broad Market Index, such bonds must be issued by an issuer that (i) is created or organized in the United States or under the laws of the United States; (ii) was rated at least BBB- / Baa3 as of March 22, 2020 by a nationally recognized statistical rating organization, or if subsequently downgraded, is rated at least BB-/Ba3 at the time of index calculation; (iii) is not an insured depository institution, depository institution holding company, or subsidiary of a depository institution holding company, as such terms are defined in the Dodd-Frank Act; and in each case, the bonds must have a remaining maturity of five years or less. The weight of any one issuer’s bonds to be represented in the Broad Market Index is limited to the lesser of 10 percent of an issuer’s “maximum historical outstanding bonds” and 1.5 percent of the $750 billion combined potential size of the CCFs. The bonds of individual issuers included in the Broad Market Index according to these parameters will inform the sector composition of the index, with each issuer classified into one of twelve sectors.
The Broad Market Index will be recalculated at least every four to five weeks, and a list of bonds that are eligible for purchase will be updated more frequently to add eligible bonds and remove ineligible bonds. Issuers that drop below the minimum rating requirement or that file for bankruptcy protection will be removed from the index. While the New York Fed acknowledges that it will not be possible for the SMCCF’s purchases of Eligible Broad Market Index Bonds to exactly replicate the index at all times, its primary focus will be to track the relative weight of each sector in the index as closely as possible, in addition to generally tracking the ratings and maturity profile of the index. The SMCCF will not sell its holdings of corporate bonds in order to track the Broad Market Index.
Pace of Purchases by the SMCCF
The pace at which the SMCCF purchases bonds or ETFs is based on a percentage of average daily volumes in the respective markets. The percentage to be purchased each day depends upon several measures of corporate bond market functioning including transaction costs, bid-ask spreads, volatility and dealer inventories. Similar ETF-specific measures, such as premium or discount to net asset value and creation/redemption volumes, will be considered for ETF purchases. The updated FAQs provide that if such measures indicate improvement in market functioning to levels that reflect pre-COVID dislocation, purchases under the SMCCF are expected to slow or pause, with the ability to accelerate once again in the event of market deterioration.
Issuer and Seller Eligibility
Significant Operations in the United States. To qualify for the CCFs, issuers under the PMCCF, issuers of Eligible Individual Corporate Bonds under the SMCCF and eligible sellers under the SMCCF (together “Eligible Entities”) must be organized in the United States or under the laws of the United States with significant operations in and a majority of their employees based in the United States.
For purposes of the CCFs, the FAQs provide a non-exclusive list of examples of what would constitute “significant operations in the United States” of a prospective issuer or seller:
- greater than 50% of its consolidated assets located in the U.S.;
- greater than 50% of its annual consolidated net income generated in the U.S.;
- greater than 50% of its annual consolidated net operating revenues generated in the U.S.; or
- greater than 50% of its annual consolidated operating expenses (excluding interest expense and any other expenses associated with debt service), each as reflected in its most recent audited financial statements, generated in the U.S.
Measuring Operations and Employees. The FAQs address the question of whether operations and employees of parent entities and affiliates should be counted for purposes of establishing issuer and seller eligibility. If the Eligible Entity is not a subsidiary whose sole purpose is to issue debt, operations and employees are measured at the Eligible Entity level without consideration of any parent companies or affiliated entities. However, if the Eligible Entity is a subsidiary whose sole purpose is to issue debt, and 95% or more of the proceeds of the syndicated loan or corporate bond issuance are transferred to a corporate affiliate of such subsidiary, that corporate affiliate must also have significant operations in and a majority of its employees based in the United States.
Additional Considerations. The FAQs clarify that the following entities are eligible to participate in one or both of the CCFs, subject to satisfaction of the other eligibility requirements:
- a U.S. company that is a subsidiary of a foreign company may be an eligible issuer under the PMCCF or an issuer of Eligible Individual Corporate Bonds under the SMCCF if created or organized in the U.S., with significant operations in and a majority of its employees based in the U.S. Specifically with respect to the PMCCF, such an entity must not use proceeds derived from participation in the program for the benefit of its foreign affiliates;
- a U.S. subsidiary or U.S. branch of a foreign bank may be an eligible seller under the SMCCF if created or organized in the U.S. or under U.S. law;
- a newly-formed entity may be an eligible issuer to the PMCCF, relying on the ratings history of a U.S. affiliate that is guaranteeing the issuance; and
- a non-profit organization may be an eligible issuer under either program.
Specific Support Condition. The PMCCF and SMCCF term sheets specify that issuers under the PMCCF and issuers of Eligible Individual Corporate Bonds under the SMCCF must not have received specific support pursuant to the CARES Act. The FAQs clarify that “specific support” refers only to a loan, loan guarantee, or other investment from the Treasury Department under Section 4003(b)(1)-(3) of the CARES Act. The FAQs further clarify that an issuer may not participate in both the PMCCF and the Main Street Lending Facilities. However, eligible issuers may utilize tax credits or tax relief in the CARES Act and still participate in the CCFs.
Notably, the eligibility requirements for issuers of Eligible Broad Market Index Bonds are similar, but not identical, to those for Eligible Individual Corporate Bonds. Issuers of Eligible Broad Market Index Bonds are not required to have significant operations in the United States or to meet the specific support condition.
Seller Eligibility. The FAQs specify that the SMCCF will begin by transacting with Primary Dealers, or affiliates thereof, that meet the eligible seller criteria. However, the SMCCF will consider expanding the pool of eligible sellers to include minority, women- and veteran-owned business entities (“MWVs”). Additionally, MWV-owned businesses may participate in the future as underwriters with respect to the PMCCF and in other various roles supporting the CCFs. Further details are expected to be provided at a later date.
Compliance and Certifications
While the FAQs provide some details, the compliance and certification requirements for entities interested in participating in the CCFs are not yet final. Issuers of Eligible Broad Market Index Bonds will not be required to provide certifications under Section 13(3) of the Federal Reserve Act for purposes of the SMCCF. Issuers of Eligible Individual Corporate Bonds may be required to provide certifications, the criteria for which will be provided before the SMCCF begins Eligible Individual Corporate Bond purchases. PMCCF issuers must certify that they are both solvent and unable to secure adequate alternative credit accommodations, consistent with Section 13(3). Notably, the FAQs clarify that a lack of “adequate credit” does not mean that no credit is available. Available credit at prices or on conditions that are not consistent with a “normal” market could support the required certification. The New York Fed will require evidence of such inability, but it has not yet specified the type or manner of such evidence.
On May 5, 2020, the New York Fed posted a seller certification packet for the SMCCF on its website, which includes form seller certifications as to solvency, the U.S. business requirement and the conflicts of interest requirements under Section 4019. The packet also includes a verification pursuant to which the seller will agree to maintain records containing the bases for such certifications, to be provided to the New York Fed upon request. The seller certification packet is available here. The updated FAQs indicate that further information on the issuer certification requirements will be provided before the SMCCF begins Eligible Individual Corporate Bond purchases.
The New York Fed also clarified certain asset eligibility requirements in the updated FAQs:
- the CCFs will not purchase non-U.S. denominated corporate bond issues;
- the CCFs do not expect to purchase corporate bonds that are widely considered to be subordinated to other corporate bonds of the issuer;
- the CCFs will not purchase bonds issued by U.S. branches, agencies or subsidiaries of non-U.S. banking organizations;
- the CCFs will not purchase bonds of issuers that are majority-owned or controlled by a foreign government;
- where the PMCCF is the sole participant in an offering, it will only purchase fixed-rate bonds. In the event that the PMCCF is approached to participate in a syndication of floating-rate debt, it will expect any debt priced by reference to LIBOR to include adequate fallback language. The SMCCF will purchase a range of bonds, including floating-rate debt that is priced off LIBOR;
- ETFs purchased by the SMCCF may include underlying bonds with maturities of greater than five years, or that would otherwise be ineligible for purchase by the SMCCF. The SMCCF will generally not purchase ETFs that are trading at a premium above the lower of the following, relative to the prior end-of-day net asset value (NAV): (i) 1% or (ii) the 1-standard deviation level of the ETF’s premium to end-of-day NAV over the prior 52 weeks, on a rolling basis; and
- the CCFs may purchase privately placed corporate bonds issued pursuant to Rule 144A.
Other Terms and Clarifications
The New York Fed will disclose information regarding the CCFs during the duration of the programs, including participants, transaction sizes, costs, revenues and other fees.
Initially, BlackRock Financial Markets Advisory will serve as the investment manager for the CCFs, acting at the sole direction of the New York Fed on behalf of the facilities pursuant to investment guidelines provided by the New York Fed. Once the urgent need to commence the programs has passed, the role of investment manager will be subject to a competitive process.
Issuers may participate in both the PMCCF and the SMCCF at the same time, assuming per-issuer limits are satisfied without exceeding the total debt allowed under the facilities. If the SMCCF purchases a particular issuer’s corporate bonds prior to the issuer issuing to the PMCCF, it will reduce the issuer’s capacity available under the PMCCF.
The New York Fed also clarified that there is no minimum issuance amount when the PMCCF purchases eligible corporate bonds as the sole investor. Further, while there is no specific minimum, eligible issuers are not expected to use the PMCCF to borrow small amounts or percentages of the total deal where multiple investors are involved.
As noted in the FAQs, we expect the New York Fed to issue further guidance on the PMCCF prior to its launch. We will continue to monitor the New York Fed and Treasury Department announcements for additional information and guidance.
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 It is unclear from the FAQs whether the former limitation should be read literally, such that the cap will be calculated according to the issuer’s maximum outstanding bonds at any point in its operating history or whether, instead, the single-issuer cap that applies to all bonds purchased in the CCFs of 10 percent of an issuer’s maximum bonds outstanding “on any day between March 22, 2019 and March 22, 2020” will be applied. We believe a reasonable reading would be to apply the same one-year window for weighting in the Broad Market Index that is applied to the single-issuer cap.