Cross-posted from AFR’s Medium page.

Can BlackRock Benefit from Inside Information from Fed Facilities?

The Fed’s Agreement with BlackRock Raises Questions about Inside Information

In order to respond to the ongoing pandemic, the Federal Reserve has created several facilities to purchase financial securities in order to attempt to stabilize the markets. Rather than run all of these programs themselves, the Fed has outsourced management of several relief facilities to the asset manager BlackRock. Examining the management agreements shows the enormous power that they grant BlackRock — including potentially the power to use inside information on the Federal Reserve’s plans in other areas of their business, or even potentially for BlackRock’s executives personal trading.

On March 23, the Fed announced the creation of the Secondary Market Corporate Credit Facility (or SMCCF for short), with the goal of providing “liquidity for outstanding corporate bonds.” The Fed will use the SMCCF to purchase certain corporate bonds, but also U.S.-listed exchange-traded funds (ETFs). ETFs are securities created by asset managers like BlackRock to track the performance of certain financial products. The ETFs the Fed will be purchasing are those “whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds.” (BlackRock, it is worth noting, is the issuer of one such ETF that tracks corporate bonds: HYG, High Yield Corp Bond).

On May 11, the Fed announced the terms of its agreement with private asset manager BlackRock, who the Fed tapped to manage the SMCCF.

The purchases will be run out of BlackRock’s Financial Markets Advisory (FMA) division, which was formed in the aftermath of the last financial crisis to help troubled financial institutions and central banks assess and manage portfolios of assets. The FMA is functionally separate from the rest of BlackRock — it has a separate set of employees and technology systems than BlackRock’s traditional businesses, due to the highly sensitive nature of its work.

What the Fed is going to purchase through the SMCCF is extremely valuable, market-moving information. Should someone know what the Fed plans to purchase prior to it doing so, they could purchase those corporate bonds, ETFs, as well as the bonds held inside the ETFs and almost certainly benefit from the inevitable price boost as the Fed begins to make its purchases. That’s why, in the agreement, people within the FMA who have access to this material non-public information are segregated from the rest of the firm through a figurative “wall” between FMA operations and the rest of BlackRock. However, this “wall” between FMA employees receiving confidential information from the Federal Reserve facility and the rest of BlackRock’s operations seems to be extremely porous.

To begin with, there is a significant exception made for BlackRock senior executives (emphasis ours):

Under BlackRock’s Information Barrier Policies and Procedures, certain BlackRock senior executives may sit atop of the information barrier between the FMA Group and the rest of BlackRock. Because of the scope of their job responsibilities, these persons may have access to Confidential Information on one side of a wall while carrying out duties on the other side of the wall. BlackRock’s Information Barrier Policies and Procedures require persons sitting atop of the wall to exercise particular caution to avoid the improper dissemination or misuse of confidential information in accordance with BlackRock’s Information Barrier Policies and Procedures.

Thus, the Fed will apparently allow top BlackRock executives to access this confidential information, even though they are still doing day-to-day work at the rest of BlackRock. There is no definition in the agreement of what “exercise particular caution” entails. Nor are there penalties or disclosure mechanisms described should a breach of this Confidential Information occur.

It is very easy to imagine the temptation for a senior BlackRock executive to either take into account such Confidential Information as they make other business decisions, or to share it in some way with a significant BlackRock client.

Even when the information barriers are respected, the effect of the barriers doesn’t last very long. The agreement specifically allows BlackRock’s FMA employees who have previously worked with the Confidential Information to use facility confidential information for other BlackRock client purchases or even their own personal purchases, so long as they do so after waiting for a two week “cooling off period” after their last contact with confidential information. It’s worth noting that trading on such confidential information after just a short two week break would clearly be illegal for a government employee.

Even during the two week period, these employees can also provide general market advice to other parts of BlackRock, so long as the advice does not involve the specific asset classes traded by the Fed facility. In addition, this brief two week period can also be shortened with approval of the Federal Reserve Bank of New York (FRBNY).

The document also states that even employees with current access to confidential market information can discuss general market or investment information such as “general credit/issuer data, economic/market data and information on general investment strategies, macro investment themes and modeling or analytic techniques” with employees in other parts of BlackRock so long as confidential information from the Federal Reserve facility is not shared in such discussions.

The SMCCF isn’t the only facility that the Fed has tapped BlackRock to run. BlackRock is also managing the Federal Reserve’s primary corporate credit purchase facility and the Fed’s agency commercial mortgage backed securities purchasing. The Fed’s March 25 agreement with BlackRock regarding the commercial mortgage facility contained language very similar to that discussed above.

Both agreements noted that BlackRock will maintain a list of those people with access to Confidential Information, and that this list will be provided should the FRBNY request it:

The BlackRock Legal and Compliance Department shall maintain a list of all Restricted Persons, including each Restricted Person’s name, title and the date he or she became a Restricted Person, as well as the date of removal from the list. Such list shall be provided to FRBNY upon request.

Both agreements also require that either internal audit or compliance review their “ethical wall policy” at least once within the first six months, and after that, at least annually. After each review, a report is to be provided to the FRBNY. But it’s not clear if this report will be made available publicly.

In order to address concerns about BlackRock executives having access to Confidential Information, BlackRock and the Fed should, at a minimum:

• Release publicly the names of the senior executives who will have access to Confidential Information but still conduct regular BlackRock business.
• Clarify if these senior executives are allowed, by BlackRock policy, to trade for their own accounts. If so, clarify if they are subject to the two-week “cooling off period” that non-executives are subject to.
• Make public the report provided to FRBNY on the review of the “ethical wall policy” implementation.
• Elaborate on what is meant by “exercise particular caution” when executives handle material non-public information.
• Extend the “cooling off period” to several months. Many investment firms require their departing employees to take anywhere between three months to a year before starting at their future employer and a similar standard needs to be applied here.
• Restrict contacts and discussions regarding general market information and advice between current and recent FMA employees with access to confidential Federal Reserve information and other parts of BlackRock.

More broadly, the Federal Reserve should clarify the role that BlackRock seems to be playing as an almost quasi-public entity with a large amount of discretion as to investing public money and very porous boundaries between the BlackRock division that invests taxpayer funds and other parts of the BlackRock corporation. There are significant competitive and equity concerns about granting this kind of power to a large private corporation.