Federal Reserve Restricts Certain Money Market Fund Access to Repo Facility

On April 25, 2023, the Federal Reserve Bank of New York (“FRBNY”) announced changes to its eligibility criteria for access to the Overnight Reverse Repo Facility (“RRP”).¹ These changes may prevent certain money market mutual funds from placing funds with FRBNY and force them to deploy funds directly in investment securities or a traditional bank account.

In this Legal Update, we provide background on the RRP and discuss FRBNY’s recent changes.

Background

In 2013, the Federal Open Market Committee (“FOMC”) first authorized FRBNY to conduct a series of fixed-rate overnight reverse repurchase operations involving US government securities, including agency securities. This authorization became a permanent operation when FRBNY established the RRP in October 2014. In transactions through the RRP, FRBNY sells a US government security and agrees to repurchase it later. The four types of financial institutions eligible to serve as counterparties are: primary dealers, banks (domestic and foreign banking offices in the United States), government-sponsored enterprises, and money market mutual funds. Insured depository institutions can maintain reserve balances of cash at an account at their local Federal Reserve Banks, and so the primary users of the RRP have been money market mutual funds.

For the Federal Reserve, these transactions help FOMC control the federal funds rate and generate additional deposits at the Federal Reserve. In effect, the RRP represents a short-term loan to the Federal Reserve that is secured by US government securities.

For participants, the benefit of RRP is that it provides a means to deposit cash with the Fed and receive interest on the deposit instead of depositing it with a commercial bank. Because the Fed is a nearly risk-free counterparty, money market funds, which otherwise do not have access to Fed accounts, have become very active participants in RRP. In effect, certain money market funds are moving deposits from commercial banks to the Fed, reducing deposit funding for the banking system. This problem appears to have grown as some money market funds may have been established for the purpose of placing cash at FRBNY.

April 2023 Change

Due to concerns about the use of RRP by some money market mutual funds in a way contrary to FOMC’s intent, the FRBNY announced new changes to the program. The changes are intended to restrict the program to only money market funds that seek to deposit excess cash in connection with the fund’s normal investment operations. The changes seek to prevent the use of the RRP as a means for a person to obtain a de facto Fed account.

Under the FRBNY’s proposed changes, eligibility for RRP will require a money market fund to represent whether it is organized for the purpose – in whole or in part – of accessing the RRP. The fund also must disclose whether it is organized for a single beneficial owner or exhibits similarities to such a fund.

FRBNY states that this change is intended to clarify that accessing the RRP should be a natural extension of an existing business model, and the counterparty should not be organized for the purpose of accessing the RRP. Therefore, money market mutual funds that are organized for a single beneficial owner, or exhibit sufficient similarities to a fund organized to do so, generally will be deemed ineligible to access the RRP. However, this should not disqualify a fund that serves as the cash management vehicle for multiple funds or investment entities in an investment fund complex from accessing the RRP. Given the lack of explanation in the statement on how FRBNY will determine the structure and purpose of a fund, it is unclear how or when it will make the disqualification determinations.  

Takeaways

The Federal Reserve Board has been concerned for many years with banks with certain business models obtaining access to its services. This is because the Federal Reserve Board is concerned that inappropriate access to government-provided financial services may displace the role of traditional commercial banks, impair the liquidity transformation process, and reduce private sector lending. Therefore, it is not surprising that the FRBNY would move to tighten the eligibility criteria for money market mutual funds to access the RRP. Going forward, certain money market mutual funds that previously relied on the RRP will be expected to place cash with a commercial bank (which may use the deposits to make loans in the real economy) or invest directly in assets (which support the functioning of the real economy).² Accordingly, the expected end result is that the change is likely to remove a desirable cash holding option for money market mutual funds and entities that might seek to set up captive funds to access the RRP.

¹ FRBNY, Statement Regarding the Policy on Counterparties for Market Operations and Reverse Repurchase Counterparties (Apr. 25, 2023), https://www.newyorkfed.org/markets/opolicy/operating_policy_230425.

² FRBNY publishes a list of counterparties that have access to the RRP. FRBNY, List of Reserve Repo Counterparties (Apr. 25, 2023), https://www.newyorkfed.org/markets/rrp_counterparties. It is unclear whether any existing counterparties will be affected by the FRBNY statement because all of the funds listed are traditional money market mutual funds. Further, the list has not changed since November 14, 2022, implying that there has not been a recent rush of new funds seeking to establish access.