September 24, 2019
Scope: San Bernardino County Treasurys response to SEC Comment period on Harmonization of Securities Offering Exemptions impact of private placement securities purchase restrictions on the San Bernardino County Treasury Pool.
Current Situation: The purchase of private placement securities (144a or 4(2)) requires the buyer to be a Qualified Institutional Buyer (QIB). The legal opinion of the County is that the County treasury pool cannot be considered a QIB under the current definition as defined in the Securities Act of 1933. This prohibits the County treasury pool from purchasing certain private placement securities despite have approximately $6.5 billion in pool assets.
Problems with the restriction: The Countys treasury pool is a significant buyer (depending on market conditions) of money market securities, especially commercial paper and asset backed commercial paper. The treasury pool, being primarily a liquidity vehicle, relies heavily on securities that it can use to immunize cash outflow needs. This is where the evolution of the market since the financial crisis has made liquidity management challenging for public agencies like the County.
Since the financial crisis, there has been a gradual move toward issuers preference in issuing private placement securities. Commercial paper and asset backed commercial paper issuers now choose to issue out of 4(2) and 144a programs instead of exempt programs. There are several reasons for it, but they are beyond the scope of this response. This move away from registered securities or qualified exempt securities to private placement issuance is prohibiting public agencies like the County from purchasing securities which it should be qualified to purchase.
Some examples of company programs converted to 4(2): Bank of Nova Scotia, BP plc, Chevron, Danske, Dexia, Kimberly-Clark, Nike, Nordea, Pfizer, Procter Gamble, Royal Bank of Canada, Societe Generale, Toronto Dominion and Walmart. Before the financial crisis and subsequent money market reform, money market liquidity was ample enough that such institutional constraints didnt pose a hurdle to investing. Today this delineation is clearly causing problems for public agencies such as the County. For example: the County is allowed by California Government Code and Treasurers Investment Policy to purchase Chevron medium-term-notes, which are longer than one year in maturity because they are registered. But the County cannot purchase Chevron commercial paper because its is issued as a 4(2) 144a. Even though there is no difference in credit risk between the two obligations, instead one could argue the commercial paper is less risky since it has lower maturity risk, the County cannot purchase the commercial paper. This is surely an unintended consequence of the law.
Conclusion: Relief in some form would be beneficial to public agencies like the County. Particularly in cases where buying securities that are already eligible from a credit risk standpoint but ineligible due to the technical definition of a QIB.