Canada: Private-Sector Term PRAs

In response to dislocations in credit and money markets between 2008 and 2009, the BoC announced two Private-Sector Term PRAs, the second expanding upon and replacing the first (Longworth 2009, 4). The first iteration, announced on October 14, 2008, was the Term PRA for Private Sector Money Market Instruments, which lent directly to primary dealers and indirectly to money market participants^FNHistorically, participants in Canadian money markets include: banks, credit unions (and “caisses populaires”), investment dealers and funds, pension funds, trust companies, non-financial corporations, retail investors, the Government of Canada, and the BoC (Engert, Gravelle, and Howard 2008, 3). for terms of two weeks against asset-backed commercial paper (ABCP), bankers’ acceptances (BAs), and commercial paper (CP) (BoC 2008b). The unique purpose of the program was to reach money market participants who were not eligible for the BoC’s earlier crisis liquidity programs, according to the BoC’s Deputy Governor: “[B]ecause the traditional liquidity transmission mechanism was not operating, and thus to address liquidity shortages beyond our traditional counterparties, we introduced a new term PRA facility aimed directly at large participants in the money markets” (Longworth 2009, 5).

Money market participants could only access the facility indirectly through primary dealers (BoC 2008b). This facility was designed as a backstop facility with a minimum bid rate of 75 basis points (bps) above the overnight indexed swap rate, a relatively high penalty rate. Few participants used the facility. Market funding remained available during this period and the BoC believed conditions in the market were not stressed enough for a large group of counterparties to demand liquidity at the rate charged (Zorn, Wilkins, and Engert 2009, 8; Longworth 2009).

To promote liquidity in corporate bond markets, the BoC announced on February 23, 2009, that it would replace this facility with a new Term PRA for Private Sector Instruments. For the second Private-Sector Term PRA, the BoC added corporate bonds rated BBB or above to the list of eligible collateral; made the program available to more market participants—those that could “demonstrate significant activity” in bond markets; and extended the terms from two weeks to one-to-three months. Counterparties continued to transact with the BoC indirectly through primary dealers. However, the BoC no longer allowed primary dealers to bid on their own behalf (Longworth 2009, 4; BoC 2009a).

With the expanded terms of the second Private-Sector Term PRA, the BoC sought to indirectly support Canadian credit markets by “helping to improve secondary-market liquidity and to reduce credit spreads” (Longworth 2009, 4). With declining issuance of commercial paper and fewer offers of term asset-backed securities, the BoC believed the second Private-Sector Term PRA would stimulate greater bond issuance (Longworth 2009, 4).

The Private-Sector Term PRAs complemented the BoC’s existing Term PRA program for primary dealers and banks (the “regular Term RPA”).

Although the BoC established term PRAs prior to December 2007 as a way to manage its balance sheet when demand for bank notes fluctuated, the regular Term PRAs (and Term Loan Facility, introduced around the same time) marked the first time that the BoC conducted term liquidity operations to support market-wide liquidity (Longworth 2008, 4).

The BoC regularly conducted special purchase and resale agreements (SPRAs, akin to repos^FNIn Canada, most “repos” are sell/buybacks, which reduce interaction with the payment system. Sell/buybacks are an older style of repurchase agreement that embeds interest payments into the repurchase price and accepts the manufactured payments at the repurchase data (Garriott and Gray 2016).) with primary dealers when the overnight interest rate traded above the BoC’s target rate, or sale and repurchase agreements (SRAs, akin to reverse repos) when it traded below the target rate (Engert, Gravelle, and Howard 2008, 8).

Several months prior to the launch of the Private-Sector Term PRA, the Parliament added Subparagraph 18(g)(i) to the Bank of Canada Act, which afforded the BoC broad powers to buy and sell virtually any type of security other than equities for the purposes of “conducting monetary policy or promoting the stability of the Canadian financial system” (BoC 2008d, 1).^FNSubparagraph 18(g)(ii) of the Act allows the bank to purchase any security in a crisis, including equities, “if the Governor is of the opinion that there is a severe and unusual stress on a financial market or the financial system” (Bank of Canada Act 1985). To date, the Bank has never taken action under the crisis authority in 18(g)(ii).

The Act requires the BoC to establish and publish a policy statement describing how it will administer 18(g)(i) during normal times. In July 2008, BoC Governor Mark Carney published a policy in the government’s legal gazette establishing the securities eligible for the “exceptional transactions” conducted under the authority of 18(g)(i) (BoC 2008c, 2235–36). The policy permitted the BoC to trade a wide range of securities, including the following securities accepted by the Private-Sector Term PRAs:

• Canadian dollar corporate and municipal bonds;
• Canadian dollar bankers’ acceptances with a term to maturity not exceeding 365 days; and
• Canadian dollar commercial paper, including ABCP, with a term to maturity not exceeding 365 days (BoC 2008c, 2235–36).

The Private-Sector Term PRAs complemented the regular Term PRA for primary dealers, which the BoC first introduced in December 2007. The regular Term PRA^FNFor more information on the regular Term PRA facility, see Sankar (2022). extended credit to large Canadian financial institutions for a period of up to one year to address heightened pressures in short-term funding markets (Zorn, Wilkins, and Engert 2009, 6).

On October 14, 2008, the BoC announced the first Private-Sector Term PRA targeting “non-traditional counterparties” that participated in the money market (Zorn, Wilkins, and Engert 2009, 8; BoC 2008f). In the same press release, it announced that its third iteration of the regular Term PRA would be available also to major banks.

In addition to the extraordinary measures taken in response to the financial turmoil, the BoC provided overnight funding through the Standing Liquidity Facility (SLF) (BoC n.d.; Longworth 2010, 2, 7). Since 2003, the BoC had operated SLF to advance overnight credit to Large Value Transfer System (LVTS) participants who experienced temporary liquidity shortages (BoC 2021; BoC 2004, 49). The BoC was prepared to provide long-term liquidity assistance to severely stressed financial institutions bilaterally through its Emergency Lending Assistance (ELA) (de Guzman 2016, 17, 21; Longworth 2010, 7). As discussed in Key Design Decision 2, the BoC conducted SPRAs with primary dealers when the overnight interest rate traded above the BoC’s target rate and SRAs when it traded below the target rate (Engert, Gravelle, and Howard 2008, 8). However, these tools were intended to inject or withdraw intraday liquidity for the specific purpose of reinforcing the BoC’s target overnight rate (Zorn, Wilkins, and Engert 2009, 5).

Figure 3: The Bank of Canada’s Liquidity Facilities

The BoC announced the details of the Private-Sector Term PRAs and established the terms and conditions (BoC 2008f; BoC 2009b).

The BoC limited participants to two bids each. Participants submitted bids on a yield basis up to three decimal points (BoC 2008a). Participants submitted bids to the BoC through primary dealers, and these bids would be confirmed by the primary dealers via fax (BoC 2009a). Participants bid a minimum of CAD 25 million and in increments of CAD 5 million thereafter (BoC 2009a). The BoC initially set the minimum bid rate at a 75-bp premium to the target overnight rate, and in February 2009 cut this to a 25-bp premium (Zorn, Wilkins, and Engert 2009, 15). The BoC allocated funds to all bids at or above the cut-off (minimum accepted) yield. Bids at the cut-off yield were pro-rated and rounded to the nearest CAD million (BoC 2008b).

The BoC set out terms and conditions of the Private-Sector Term PRAs and had the right to revise them as well as the ability to reject bids in whole or in part (BoC 2009a).

The first Private-Sector Term PRA could be tapped by primary dealers and “non-traditional counterparties,” meaning market participants who could demonstrate a significant role in Canadian money markets and were subject to Federal or Provincial regulation (Zorn, Wilkins, and Engert 2009, 8). These non-traditional counterparties may have included deposit-taking institutions, such as mortgage loan companies or trust companies; money market mutual funds; and other large investment managers. Participants placed bids through primary dealers, which prevented market participants from crowding out the traditional market-makers (BoC 2009b; Zorn, Wilkins, and Engert 2009, 8,11). The BoC required participants bidding indirectly in this way to submit their bids through a single primary dealer and complete an application form and PRA agreement at least two business days prior to the auction­ (BoC 2009a).

The second Private-Sector Term PRA also allowed participants who could demonstrate significant activity in bond markets (BoC 2009a). For the second facility, primary dealers were no longer eligible to bid on their own behalf, and only bid on behalf of other participants. They remained eligible for the regular Term PRA (Zorn, Wilkins, and Engert 2009, 11).

Private-Sector Term PRA advances were reported on the BoC’s balance sheet (BoC 2011).

In each auction announcement, the BoC stated that funding would be available through the Private-Sector Term PRA for “as long as conditions in financial markets warrant” (BoC 2009d). From the first auction on October 27, 2008, through mid-2009, the BoC was prepared to allocate CAD 1 billion to each auction (BoC 2008i; BoC 2008g). Beginning in July 2009, this was reduced to CAD 500 million (Zorn, Wilkins, and Engert 2009, 9; BoC 2009e).

In the first iteration of the facility, each participant could bid up to 25% of the amount allocated by the BoC to the auction (BoC 2008b). The second iteration of the facility allowed participants to bid up to the greater of 25% of the amount auctioned or CAD 250 million. The BoC considered affiliated participants as a single bidder (BoC 2009a).

The BoC combined primary dealers’ exposure to the first Private-Sector Term PRAs with their exposure to the regular Term PRA if the amount allocated was greater than CAD 50 million (par amount) (BoC 2008b).

Initially, the BoC stated a participant allocated more than CAD 50 million could pledge the obligation of a single issuer (private, municipal, or foreign) only up to a cumulative amount of 20% of the par value of Term PRAs outstanding with that participant. Later terms indicated that a single participant could offer up to CAD 100 million (par amount) of any single issuer, and no more than 50% of a total bond’s issuance (BoC 2008b; BoC 2009a).

The first iteration of the Private-Sector Term PRA announced in October 2008 charged a stop-out rate of the lowest accepted bid, with a high minimum bid rate of a 75-bp premium to the average of the BoC’s overnight target rate and the one-month overnight indexed swap rate observed by the BoC (Zorn, Wilkins, and Engert 2009, 19). The rate applied to the second iteration of the Private-Sector Term PRA announced in February 2009 was effectively a 25-bp premium to the target overnight rate (Engert, Selody, and Carolyn 2008, 10; Zorn, Wilkins, and Engert 2009, 19). This rate was calculated as the sum of (1) the term overnight indexed swap rate observed by the BoC prior to the auction; (2) the higher of zero, or the difference between the average yield of the preceding regular Term PRA auction and the corresponding term overnight indexed swap rate for that operation; and (3) 25 bps (BoC 2009a).

The first iteration of the Private-Sector Term PRA accepted highly rated bankers’ acceptances and promissory notes and commercial paper with remaining maturities of less than one year, as well as highly rated asset-backed commercial paper (ABCP)(Bank of Canada 2008) (see Figure 4). The BoC intended the inclusion of ABCP to address the dislocations in ABCP markets that resulted from the global downgrades of subprime mortgage-backed structured products, especially in the United States (Longworth 2008, 2). The BoC applied the same collateral schedule used in its regular Term PRA operations (BoC 2009b; BoC 2010) (for the full collateral schedule, see BoC 2010).

Figure 4: Eligible Collateral Ratings for Private-Sector Term PRAs

The second Private-Sector Term PRA added investment-grade corporate bonds to the list of eligible collateral (BoC 2009a).

Securities issued or guaranteed by affiliates of the bidder or related parties were ineligible for the Private-Sector Term PRAs, except for bank-sponsored ABCP that met the BoC’s criteria^FNWhen the BoC launched the Private-Sector Term PRA in October 2008, bank-sponsored ABCP was temporarily eligible for the regular term PRAs (BoC 2008b). (BoC 2009b). Convertible securities or those with an embedded option were ineligible (BoC 2009b). The BoC required a minimum principal amount of CAD 10 million for any individual security to be considered as eligible collateral (BoC 2009b). If collateral fell below a threshold considered “acceptable” to the BoC, it would be subject to a margin call (BoC 2008b).

The first Private-Sector Term PRA offered terms of two weeks^FNOn December 15, 2008, the first iteration of the Private-Sector Term PRA held one auction for a three-week term; this auction was unsubscribed (BoC 2013c).  (BoC 2013a). Beginning in February 2009, the second Private-Sector Term PRA offered terms of one- to three-months (BoC 2009a).

Research did not determine other conditions applied to the Private-Sector Term PRAs.

The BoC lowered its overnight target rate from 2.75% to 2.25% on October 8, 2008, and again on October 21 from 2.25% to 2.50% upon announcing it would respond to financial market stress with the provision of extraordinary liquidity measures coordinated with central banks in the US, UK, and EU (BoC 2008h). Another 75-bp rate cut followed in December 2008 which, in addition to the BoC’s liquidity provision, helped to reduce the spread between the weighted average of bank borrowing rates and the BoC’s expected overnight rate (BoC 2009h, 6). The BoC estimated that this spread narrowed from a peak of 200 bps in October 2008 to roughly 170 bps in January 2009, reducing overall bank funding costs by about 100 bps (BoC 2009h, 6).

In April 2009, the BoC lowered the overnight target rate from 50 bps to 25 bps (FRED n.d.). To reinforce the commitment to hold the policy rate at 25 bps, the BOC reduced the minimum bid rate for the Private-Sector Term PRA to a 25-bp premium to the target overnight rate (Zorn, Wilkins, and Engert 2009, 10). The BoC intended its regular Term PRA facility to reinforce this target rate, but this was not an explicit intent of the Term PRA for Private Sector Instruments (Longworth 2010, 6).

Research did not determine other options considered by the BoC.

The first Private-Sector Term PRA, which supported money markets by providing a source of liquidity for illiquid asset-backed commercial paper, resembled the Federal Reserve’s Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) in intent (Wiggins 2020). The Private-Sector Term PRAs were distinguished by their auction mechanism, which followed from principles of market intervention adopted by the BoC (Longworth 2010, 3–4). Although many central banks accepted government bonds and covered bonds, the second iteration of the Private-Sector Term PRA provided liquidity for investment-grade corporate bonds.

The BoC announced the first iteration of the facility, the Term PRA Facility for Private Sector Money Market Instruments, in a press release dated October 14, 2008, as part of a commitment to provide “extraordinary liquidity” in conjunction with central banks in the US, UK, and EU under a G7 Plan of Action. The BoC sought to enhance the functioning of money markets by offering term PRAs to money market participants on an indirect basis (BoC 2008f). This announcement also contained details of the first Private-Sector Term PRA auction, scheduled for October 27, 2008 (BoC 2008e).

Leading up to the replacement of the first iteration, the BoC continued to announce auctions but did not make comment on the efficacy of the first iteration of the facility. In a press release dated February 23, 2009, the BoC announced that the first facility would be replaced by an expanded second iteration that would include corporate bonds. It used similar language to describe the purpose of the program: “to support the efficient functioning of the market for private-sector securities” (BoC 2009b). The BoC stated its preference for using term PRAs to deal with market-wide distortions in liquidity premiums (Engert, Selody, and Carolyn 2008, 77). In 2010, Deputy Governor David Longworth stated that the presence of the Private-Sector Term PRAs and the TLF “helped to mitigate uncertainty among market participants about the availability of liquidity” (Longworth 2010, 6).

Early in the crisis, the BoC stated its intent to “actively communicate any unusual steps taken in its operations, as well as the reasons for those steps,” citing speeches made by BoC Governor Mark Carney and Deputy Governor Longworth, as well as BoC staff outreach to market participants (Longworth 2008, 5). In the week after announcing the terms and conditions of the second iteration of the facility, the BoC gathered feedback from market participants (BoC 2009b). Deputy Governor Longworth stated that “we have been clear about our liquidity operations, both when we expanded them and when we became the first major central bank to end special operations” (Longworth 2008, 5).

The BoC periodically announced a schedule of forthcoming auctions (BoC 2009c). On the day of settlement, the BoC published the amount bid, the final allocation, and the yield (BoC 2008j).

The BoC designed the facilities around principles for market-based transactions (such as auction mechanisms at market-determined prices) to target systemic liquidity distortions and direct lending to specific institutions facing liquidity shortages (Longworth 2010, 6–7). The BoC said that its interventions should be appropriately sized to the severity of the problem and mitigate moral hazard through selective intervention or penalty pricing (Longworth 2010, 3). The BoC considered term purchase and resale agreements as the most appropriate form of intervention for providing liquidity to money markets when liquidity premiums in money markets experience widespread distortion due to problems in an asset class or maturity since eligible financial market participants are allowed to transact with marketable securities (Engert, Selody, and Carolyn 2008, 77).

The BoC published aggregate data on its liquidity facilities on a monthly basis but did not reveal details about the collateral posted by participants nor the funds they received in return (Macdonald 2012, 36).

The BoC did not articulate a strategy to minimize stigma for the Private-Sector Term PRAs. The BoC designed these facilities for non-traditional counterparties, such as asset managers, which do not have access to the BoC’s standing liquidity facility or emergency lending assistance.

The BoC designed the Private-Sector Term PRA as a backstop facility that charged a penalty rate that provided the Bank with “a natural means to exit” once participants could source market financing (Zorn, Wilkins, and Engert 2009, 11).

Following the announcement of the updated Private-Sector Term PRA in February 2009, more bidders participated in the auctions (BoC 2013c). Term funding peaked at CAD 3 billion in summer 2009, at which point auctions saw fewer bids and the BoC observed a general improvement in funding conditions. As a result, the BoC allowed the facility to expire on October 27, 2009 (along with the Term Loan Facility) (Zorn, Wilkins, and Engert 2009, 15–16; BoC 2009g, 14). The final maturity date was January 14, 2010 (BoC 2009f).