Banking and Finance Law Daily Interim final rule neutralizes LCR effects for MMLF, PPLF participants
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Tuesday, May 5, 2020

Interim final rule neutralizes LCR effects for MMLF, PPLF participants

By Colleen M. Svelnis, J.D.

The banking regulatory agencies have issued an interim final rule that requires banks to neutralize the effect under the Liquidity Coverage Ratio rule of participating in the MMLF and PPLF.

The Office of the Comptroller of the Currency, Federal Reserve Board, and Federal Deposit Insurance Corporation have issued an interim final rule that would keep companies participating in the Money Market Mutual Fund Liquidity Facility (MMLF) and the Paycheck Protection Program Liquidity Facility (PPPLF) from being negatively affected by the Liquidity Coverage Ratio (LCR) rule. The interim final rule requires companies to neutralize the effect under the LCR rule of participating in the MMLF and the PPPLF, and is intended to facilitate use of the lending facilities and to ensure that the effects of their use are consistent and predictable under the LCR rule. The notice will be published in the Federal Register on May 6, 2020. Comments are requested by June 5, 2020.

The LCR rule created the first standardized minimum liquidity requirement for large and internationally active banking organizations. The rule requires each covered institution to hold high-quality, liquid assets (HQLA), such as central bank reserves and government and corporate debt that can be converted easily and quickly into cash, in an amount at least equal to the institution’s projected net cash outflow during a 30-day stress period. A covered company’s LCR is the ratio of its HQLA amount (LCR numerator) divided by its total net cash outflows (LCR denominator).

Lending facilities. In order to provide liquidity to the money market sector, small business lenders, and the broader credit markets and to help stabilize the financial system during the coronavirus pandemic, the banking agencies authorized the establishment of the MMLF and the PPPLF. Eligible borrowers under the MMLF include certain banking organizations subject to the LCR rule.

MMLF collateral generally comprises securities and other assets with the same maturity date as the MMLF non-recourse loan. Under the PPPLF, only PPP covered loans that are guaranteed by the Small Business Administration under the PPP with respect to both principal and interest and that are originated by an eligible institution may be pledged as collateral to the Federal Reserve Banks (PPPLF collateral). The maturity date of the extension of credit under the PPPLF equals the maturity date of the PPP loans pledged to secure the extension of credit.

According to the agencies, the problem is that under the LCR rule, secured loans from a Federal Reserve facility with a remaining maturity of 30 calendar days or less are categorized as secured funding transactions with a sovereign entity and assigned an outflow rate that varies based on the collateral securing the loan. As a result, MMLF and PPPLF transactions could receive a non-neutral liquidity risk treatment and unnecessarily contribute to volatility in LCRs. Under the terms of the MMLF and PPPLF, covered companies use the value of cash received from posted or pledged assets to repay the MMLF or PPPLF loan, and in no case is the maturity of the collateral shorter than the maturity of the advance.

Absent the interim final rule, under the LCR rule, covered companies would be required to recognize 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 covered company’s participation in the MMLF or PPPLF could affect its total net cash outflows, which could potentially result in an inconsistent, unpredictable, and more volatile calculation of LCR requirements across covered companies

New definitions added. The interim final rule adds a new definition and a new section to the LCR rule. The new definition, "Covered Federal Reserve Facility Funding," means a non-recourse loan that is extended as part of the MMLF or PPLF. The new section 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 the LCR rule, notwithstanding any other section of the LCR rule. In most cases, this new section excludes advances made by a Federal Reserve Bank under the MMLF or the PPPLF from being assigned an outflow rate, and any collateral securing such an advance from being assigned an inflow rate.

MainStory: TopStory BankingFinance BankingOperations CapitalBaselAccords Covid19 FederalReserveSystem FinancialStability Loans PrudentialRegulation SecuritiesDerivatives

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