On March 23, 2020, as part of its response to the COVID-19 pandemic, the Federal Reserve Board (Fed) announced the establishment of a Term Asset-Backed Securities Loan Facility (TALF 2020) to support the asset-backed securities (ABS) market and indirectly provide loans to the U.S. companies whose debt underlies the ABS.1 The Fed has indicated that TALF 2020 will be primarily modeled after the terms and conditions of the Term Asset-Backed Securities Loan Facility used during the financial crisis of 2007-2009, which was announced in 2008 (TALF 2008).
The Securities and Exchange Commission (SEC) staff (Staff) issued two no-action letters in 2009 to address the participation by investment companies (funds) registered under the Investment Company Act of 1940, as amended (1940 Act) in TALF 2008. On May 27, 2020, in a letter addressed to the Investment Company Institute (ICI) and the Securities Industry and Financial Markets Association (SIFMA), the Staff confirmed that the relief provided in the 2009 letters could apply, subject to substantially the same conditions, to funds’ participation in TALF 2020 with substantially similar facts and circumstances.2 As discussed below, the Staff also expanded this relief. After providing background summarizing the relevant features of TALF 2020, this memorandum discusses considerations relevant to funds that may wish to participate in TALF 2020.
Based on the most recent term sheet that was released for TALF 2020, which is subject to change, and the related FAQ, a fund (or a pooled investment vehicle) is an eligible borrower if: (i) both the fund or the pooled investment vehicle and its adviser were created or organized in the United States; (ii) the fund’s or pooled investment vehicle’s adviser has significant operations in and a majority of its employees based in the United States; and (iii) the fund or pooled investment vehicle maintains an account relationship with a primary dealer.3 For purposes of making $100 billion of loans available under the program against eligible collateral (minus the applicable haircut amounts), the Fed will form and capitalize a special purpose vehicle (SPV), and the Federal Reserve Bank of New York (FRBNY) will lend, on a recourse basis, to the SPV.
The primary dealer will perform various duties as agent for an eligible borrower, including: (i) receiving the initial disbursement of loan proceeds to the account at the primary dealer, which the primary dealer will then transmit to the eligible borrower; and (ii) receiving from the eligible borrower the fees and eligible collateral needed for closing on the loan in the account at the primary dealer, which the primary dealer will then transfer to FRBNY or FRBNY’s custodian and administrator. Eligible collateral during the term of any loan will be held in a master collateral account that is maintained by the custodian and administrator on behalf of FRBNY in an omnibus account. TALF 2020 loans will be non-recourse to the eligible borrower, provided the applicable terms of the TALF 2020 program are met.
1940 Act Issues for Funds
As noted above, the Staff issued two no-action letters in 2009, one to Franklin Templeton and one to T. Rowe Price, addressing certain issues arising under the 1940 Act with their funds’ participation in the TALF 2008 program.4 In the recent ICI/SIFMA Letter, the Staff stated that “the terms and conditions of TALF 2020 are substantially similar to those of TALF 2008 for purposes of the staff no-action positions taken in the [Franklin Letter and T. Rowe Letter]” and confirmed that the relief provided in the 2009 letters could, subject to substantially similar conditions, be available for funds seeking to participate in TALF 2020 with substantially similar facts and circumstances. The 2009 letters and the issues that they addressed, as modified by the ICI/SIFMA Letter, are discussed below.5
The Franklin Letter dealt with two issues raised under the 1940 Act by funds’ participation in TALF 2008: one under Section 18 of the 1940 Act and applicable SEC interpretations regarding asset coverage and segregation requirements and the other under Section 17(f) and rules thereunder relating to custody of fund assets. The Staff agreed with Franklin Templeton’s proposal in the context of TALF 2008 to treat loans under that program as reverse repurchase agreement (reverse repo) transactions. To address Section 18 concerns under prior SEC guidance, this would have required (if the reverse repo lacks a specified repurchase price) the segregation of liquid assets in an amount equal to the proceeds received from the counterparty plus any accrued interest.6 In the Franklin Letter, to meet this asset segregation requirement, the fund proposed to segregate and maintain liquid assets marked-to-market daily in an amount equal to the fund’s outstanding principal and interest on the TALF 2008 loan, excluding eligible collateral. Because the TALF 2008 loan is nonrecourse to the fund, this segregation requirement was expected to result in at least 200% asset coverage for the borrowing.
Because a primary dealer held fund assets for a time in connection with the TALF 2008 loan, this also raised a custody issue under Section 17(f) of the 1940 Act and the rules thereunder, which generally requires funds to maintain their assets in custody with a bank (or other approved entity under applicable rules). In the Franklin Letter, the Staff provided no-action relief with respect to Section 17(f) to the extent that a primary dealer could be viewed as custodian of a fund’s assets.
T. Rowe Letter
Certain affiliated transaction issues under Section 17 of the 1940 Act and Rule 17d-1 thereunder were addressed in the T. Rowe Letter as a result of T. Rowe Price’s proposed use of a pooled investment vehicle advised by T. Rowe (Private Fund) to aggregate various client investments in TALF 2008 loans. The Private Fund was structured to aggregate investments in TALF 2008 loans across T. Rowe Price’s advised and subadvised funds (Price Funds) and certain institutional separate accounts and common trust funds managed by T. Rowe Price. Because the Price Funds and the Private Fund would be managed by T. Rowe or an entity controlling, controlled by or under common control with T. Rowe, a Price Fund and the Private Fund could be deemed to be affiliates of one another, or affiliates of affiliates of one another. To invest in TALF 2008 loans, a Price Fund would engage in purchase and sale transactions as a principal directly with the Private Fund in order to purchase interests in the Private Fund for cash or in-kind for eligible collateral. The Price Funds and Accounts invested in the Private Fund would also pay the operating expenses of the Private Fund and share in gains resulting from the Private Fund’s TALF 2008 loans. Thus, this arrangement raised issues under Sections 17(a) and 17(d) and Rule 17d-1 under the 1940 Act.
The relief in the T. Rowe Letter was subject to several conditions that addressed concerns related to the relief being requested under Section 17 and Rule 17d-1 (such as the concern that the adviser or subadviser would make investments without taking each fund’s interests and investment objectives, policies and restrictions into account) and other concerns (such as the potential for layering of fees through the imposition of sales charges in the context of fund-of-funds investments). In the ICI/SIFMA Letter, the Staff confirmed that condition 2 of the T. Rowe Letter (which prohibited an advised Price Fund from investing in the Private Fund unless it had an operating policy that restricted the advised Price Fund from purchasing additional securities to the extent it has borrowed in excess of 5% of the advised Price Fund’s assets) will not apply to funds eligible to rely on the T. Rowe Letter for TALF 2020.
S&K Observations and Insights
Now that the Staff has confirmed that the relief provided by the Franklin Letter and T. Rowe Letter could apply to TALF 2020 and extended the T. Rowe Letter to third parties, a fund has the flexibility to participate in TALF 2020 directly by relying on the Franklin Letter or indirectly by relying on the T. Rowe Letter if the fund’s facts and circumstances are substantially similar and subject to the conditions in those letters (as modified by the ICI/SIFMA Letter). In this regard, it is worth noting that the T. Rowe Letter does not impose Section 18 asset segregation requirements on a fund investing indirectly through an unregistered vehicle in TALF 2020. Fund sponsors with funds that can participate in TALF 2020 should consider whether the investment policies and restrictions of funds they manage can accommodate the minimum TALF 2020 loan size to invest directly (currently, $5,000,000), and whether other accounts or unregistered products they manage would be able to participate in TALF 2020 as part of their investment strategy.