THE VANGUARD GROUP, INC.
INTERFUND LENDING PROGRAM
INTRODUCTION
In 1987, the Securities and Exchange Commission ("SEC") granted Vanguard Funds
relief from certain sections of the Investment Company Act of 1940 ("the '40
Act") in order to establish a pooled vehicle in which participating Funds could
invest their excess cash balances. Through this arrangement ("the Joint
Account"), Funds' excess cash is aggregated and invested in a number of large,
overnight repurchase agreements on a daily basis. In 1996, each of the Vanguard
funds applied for, and received from the SEC, an exemptive order ("the Order")
providing relief from certain sections of the '40 Act to enable them to
collectively establish an interfund credit facility ("the Facility"). Each of
the funds subsequently obtained the approval of its shareholders to participate
in the program. This program will allow funds with excess cash to lend to other
funds with cash needs to the extent that the interest rate charged on the loans
is beneficial to both the borrowing and lending funds. In most cases, Funds will
lend cash which otherwise would have been directed to the Joint Account.
If there are Funds whose liquid assets (i.e., Joint Account balances and
same-day settlement holdings) are insufficient to meet their daily liquidity
requirements, while other Funds have excess liquidity (i.e., Joint Account
balances or cash flow which would be otherwise directed into the Joint Account),
VGI will operate the Credit Facility. Each Fund participating in the Facility
will benefit. Funds drawing credit from the Facility will receive needed
liquidity at interest rates lower than they would pay a commercial lender. Funds
providing credit through the Facility will receive a return on the loaned cash
that is higher than the return they would otherwise receive by investing their
cash through the Joint Account.
VGI will operate the Credit Facility subject to the conditions contained in the
exemptive order. (A recital of these conditions and our corresponding procedures
is included later in this document.) In general though, the Cash Management
Group ("CMG") within Fund Accounting will analyze each Fund's liquidity on a
daily basis to determine whether the Fund is able to participate in the Facility
as a lender (i.e., has excess liquidity) or needs to participate in the Facility
as a borrower (i.e., needs liquidity). All Funds are eligible to borrow through
the Facility, subject to limitations contained in the Order. Generally,
potential lenders will be those Funds that participate in the Joint Account.
Money Market Funds may participate as lenders so long as the portfolio manager
notifies the CMG of the amount of cash that each Fund wishes to direct to the
Credit Facility on a particular day.
Once the CMG has identified all of the potential borrowers and lenders, loans
will be allocated among them in order to minimize the number of individual loans
that have to be established. The CMG will maintain records designed to monitor
compliance with the conditions of the exemptive order for each day that the
Credit Facility is in operation. The CMG will initiate money movement among the
Funds to effect the loans and will notify the appropriate Fund Accounting areas
of lending activity. In order to ensure that
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the Facility is operating efficiently and that all issues are resolved promptly,
on each day that the Facility operates, there will be an afternoon operations
meeting of representatives from Fund Accounting, Legal and Portfolio Management
to assess the current activities of the Facility and to identify any trends or
issues.
Loans will be structured as overnight obligations that are automatically repaid
the following day. To the extent that a Fund has an ongoing need to borrow, a
new loan (or loans) will be opened the following day for the current amount of
required borrowing. This structure will ensure that loans are repaid to the
extent of any positive cash flow after they are established. It also ensures
that if a Fund experiences sudden redemptions while acting as a lender, it can
extricate itself from an open loan without necessarily having to exercise the
call feature required under the Order.
In order to adequately define the terms and conditions of each loan effected
through the Facility and to afford Funds adequate security, VGI will develop a
Master Loan Agreement ("the Agreement") to be executed by all Funds
participating in the Facility. In addition to the conditions required by the
Order, this agreement will also contain a provision requiring a borrower to
immediately sell securities with a value equal to the amount of the loan. This
will ensure that sales proceeds are available to repay the loan within a short
period of time. (To the extent that there are other amounts which the Fund
reasonably expects to receive within the following 3 business days (e.g., prior
sales proceeds, income payments, committed fund share purchases, etc.), this
mandatory sales requirement may be waived by the Pricing Review Committee (under
authority delegated by the Board).
The procedures described below are in place to ensure that the following control
objectives are met:
I. Each Fund is required to comply with the net redemption and percentage
limitations on borrowing, and the percentage limitations on lending.
II. Each Fund is required to make loans only at the interfund rate and such
rate must be higher than the Joint Account rate but lower than the lowest
available bank borrowing rate.
III. Borrowing and lending demand must be allocated among Funds in accordance
with procedures established by each Fund's Board of Trustees.
IV. If a Fund, at the time of its borrowing from another Fund, has other
outstanding borrowings, the interest rate on such interfund borrowings may
not exceed the interest rate on such other borrowings.
V. Each Fund must pledge collateral for interfund loans when, and to the
extent provided by the conditions of the Order.
The remainder of this document recites the conditions of the Order and describes
VGI's plan to ensure compliance with these conditions. The italicized text after
each of the conditions indicated how we propose to address compliance with that
condition.
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1. The interest rates to be charged to the Funds under the credit facility
will be the average of the current Joint Account repurchase agreement rate
and a benchmark rate established periodically to approximate the lowest
rate available from banks on loans to the Funds.
The current day's rate in the Joint Account is not known until the
investment is made, and the amount of the investment is not known until
it has been determined how much cash will be directed to the Facility.
Thus, it is not possible to use the exact Joint Account rate in
determining the rate on loans through the Facility. Rather, we will use
the repurchase agreement ("repo") rate obtained by the Fixed Income
Group ("FIG") at approximately 8:00 AM as a proxy for the Joint Account
rate. The use of such a rate has been approved by each Fund's Board.
Since the FIG will begin trading for the Joint Account earlier in the
morning based on estimated cash figures, it is likely that this rate
will serve as a reasonable indication of the day's Joint Account rate.
Differences between the repo rate and the actual Joint Account rate for
the day will monitored on each day that the Facility operates.
Management will report to the Board should the repo rate not continue
to represent a reasonable proxy for the Joint Account Rate.
The Cash Management Group ("CMG") has obtained information from a
number of banks representing the rates available under committed lines
of credit. These quotations will serve as the basis for the
determination of the benchmark rate on a daily basis to approximate the
cost of bank borrowing. These rates are quoted with reference to the
Federal Funds rate (e.g. Fed Funds + 50 basis points). Thus, the
variability in the bank loan rate from day to day will be solely
attributable to changes in the level of the Fed Funds rate. As such, we
will obtain the current traded Federal Funds rate at approximately 8:00
AM and adjust it by the relevant spread to calculate that day's
Benchmark Rate. The basis for this determination will documented for
each day that the Facility is in operation and will be approved by Fund
Accounting management.
The average of the benchmark rate and the repo rate will serve as the
interest rate for all loans effected through the Facility for the day
("the Daily Rate"). Under extraordinary circumstances (e.g. market
dislocation, extreme rate volatility), each Fund's Board has authorized
the Pricing Review Committee (PRC) to establish a Daily Rate that is
not the average of the Joint Account rate and the benchmark rate. In
these instances, the Daily Rate will be less than the benchmark rate
and greater than the Joint Account rate. In making its determination,
the PRC will take into account current market information regarding
availability of liquidity and will ensure that both borrowers and
lenders are offered a rate which is equal to or better than that which
they would pay/receive under an alternative transaction (i.e. borrow
from bank or invest in Joint Account). The rationale behind any such
determination will be documented and maintained on any day when the
Daily Rate is so determined.
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2. The Cash Management Department on each business day will compare the
interfund loan rate set pursuant to the formula calculated as provided in
condition 1 with the Joint Account repurchase agreement rate negotiated
that day and all short-term borrowing rates quoted to any of the Funds by
any bank with which any Fund has a loan agreement. At least three such
quotations will be obtained each day in which any Fund borrows through the
credit facility prior to such borrowing. The Cash Management Department
will make cash available for interfund loans only if the interfund rate is
more favorable to the lending Fund than the Joint Account repurchase
agreement rate and more favorable to the borrowing Fund than the lowest
quoted bank loan rate.
The CMG will evaluate the Daily Interfund Loan Rate to ensure that it
is beneficial to potential lenders and potential borrowers. In this
determination, the CMG will use the repo rate and the benchmark rate,
as determined above, as proxies for the Joint Account rate and the
"lowest quoted bank loan rate". Although it is not contemplated that
the Joint Account Rate would ever be greater than the Interfund Loan
Rate, should such instance arise, the intraday market conditions which
gave rise to the discrepancy would be documented..
3. If a Fund has outstanding borrowings, any interfund loans: (a) will be at
an interest rate equal to or lower than any outstanding bank loan; (b) will
be secured at least on an equal priority basis with at least an equivalent
percentage of collateral to loan value as any outstanding bank loan that
requires collateral; (c) will have a maturity no longer than any
outstanding bank loan (and in no event over seven days); and (d) will
provide that, if an event of default by the Fund occurs under any agreement
evidencing an outstanding bank loan to the Fund, that event of default will
automatically (without need for action or notice by the lending Fund)
constitute an immediate event of default under the interfund loan agreement
entitling the lending Fund to call the interfund loan (and exercise all
rights with respect to any collateral) and that such call will be made if
the lending bank exercises its right to call its loan under its agreement
with the Fund.
The CMG will maintain a schedule of all outstanding borrowings for each
Fund, which will detail the interest rate and collateral applicable to
such borrowings. To the extent that borrowings in addition to those
effected through the Credit Facility exist, the CMG will review this
schedule to determine that these conditions are satisfied.
4. A Fund may make an unsecured borrowing through the credit facility if its
outstanding borrowings from all sources immediately after the borrowing
total less than 10% of its total assets, provided that if a Fund has a
secured loan outstanding from any lender, including but not limited to
another Fund, the Fund's interfund borrowing will be secured on at least an
equal priority basis with at least an equivalent percentage of collateral
to loan value as any outstanding loan that requires collateral. If a Fund's
total outstanding borrowings immediately after an interfund borrowing would
be greater than 10% of its total assets, the Fund may borrow
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through the credit facility only on a secured basis. A Fund could not
borrow through the credit facility if its total outstanding borrowings
immediately after the interfund borrowing would be more than 33 1/3 % of
its total assets.
As noted above, the CMG will maintain a schedule of all outstanding
loans by Fund and the collateral requirements thereon. Additionally,
schedules maintained by the CMG will note any Fund which has exceeded
10% of its assets in borrowings and will maintain the requisite
schedule of identified collateral and mark such collateral to market on
a daily basis to ensure its ongoing sufficiency. (Note: Although the
Order provides a 33-1/3% borrowing limit, each Fund is subject to a
fundamental limitation that prohibits borrowing in excess of 15% of
total assets.)
5. Before any Fund that has outstanding interfund borrowings may, through
additional borrowings, cause its outstanding borrowings from all sources to
exceed 10% of its total assets, the Fund must first secure each outstanding
interfund loan by the pledge of segregated collateral with a market value
at least equal to 102% of the outstanding principal value of the loan.
If the total outstanding borrowings of a Fund with outstanding
interfund loans exceeds 10% of its total assets for any other reason
(such as decline in net asset value or because of shareholder
redemptions), the Fund will within one business day thereafter: (a)
repay all its outstanding interfund loans; (b) reduce its outstanding
indebtedness to 10% or less of its total assets; or (c) secure each
outstanding interfund loan by the pledge of segregated collateral with
a market value at least equal to 102% of the outstanding principal
value of the loan until the Fund's total outstanding borrowings cease
to exceed 10% of its total assets, at which time the collateral called
for by this condition 5 shall no longer be required. Until each
interfund loan that is outstanding at any time that a Fund's total
outstanding borrowings exceeds 10% is repaid or the Fund's total
outstanding borrowings cease to exceed 10% of its total assets, the
Fund will mark the value of the collateral to market each day and will
pledge such additional collateral as is necessary to maintain the
market value of the collateral that secures each outstanding interfund
loan at least equal to 102% of the outstanding principal value of the
interfund loan.
The CMG will monitor the extent of funds' borrowing on a daily basis.
If, as the result of either new loan initiation or other changes (e.g.
decrease in fund's total assets), a fund's total borrowing exceeds 10%
of total assets, the CMG will segregate sufficient collateral (and mark
such collateral to market each day) to comply with these conditions.
The collateral identified will be maintained on the schedule noted in
the 2 items above.
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6. No equity, taxable bond, or money market Fund may loan funds through the
credit facility if the loan would cause its aggregate outstanding loans
through the credit facility to exceed 5%, 7.5%, or 10%, respectively, of
its net assets at the time of the loan.
The CMG will utilize a spreadsheet in administering the Credit Facility
which will limit the amount available for loan from a particular Fund
to the appropriate percentage of assets. The spreadsheet will utilize
the prior day's total asset data from COMPASS in determining compliance
with this limitation.
7. A Fund's interfund loans to any one Fund shall not exceed 5% of the lending
Fund's net assets.
The CMG will maintain a matrix for each day on which the Facility
operates which will detail the amounts and percentages of assets of
loans effected between borrowers and lenders. The CMG will review this
matrix on a daily basis (as well as while loans are being allocated) to
ensure that a lending Fund does not commit more than 5% of its assets
to a single borrower..
8. The duration of interfund loans will be limited to the time required to
receive payment for securities sold, but in no event more than seven days.
Loans effected within seven days of each other will be treated as separate
loan transactions for purposes of this condition.
Loans will be structured as overnight obligations. This allows loans to
be repaid to the extent of net positive cash flow each day, minimizing
the exposure of lending funds. Additionally, it allows for the
reallocation of loans on a daily basis in order that lenders with
sudden cash needs have access to their own liquidity in a timely
fashion. Funds will be required to effect security sales in an amount
at least equal to the amount of the loan (or have comparable pending
receivables) under the terms and conditions of the Master Loan
Agreement. This will serve to ensure that sufficient funds are
available for repayment of the loan.
9. A Fund's borrowings through the credit facility, as measured on the day the
most recent interfund loan was made to the Fund, will not exceed 125% of
the Fund's total net cash redemptions for the preceding seven calendar
days.
The spreadsheet utilized by the CMG in administering the Facility will
aggregate data regarding the previous 7 days' shareholder activity from
COMPASS. Those days during the 7 day period on which the Fund
recognized net redemptions will be totaled in determining the basis for
the 125% test. This test will be incorporated into the spreadsheet to
prevent a Fund from initiating a loan through the Facility for more
than 125% of this net redemption total.
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10. Each interfund loan may be called on one business day's notice by the
lending Fund and may be repaid on any day by the borrowing Fund.
The structure described in item 8 above will address this limitation.
11. A Fund's participation in the credit facility must be consistent with its
investment policies and limitations and Declaration of Trust or Articles of
Incorporation.
Each of the Funds participating as a lender already invests its excess
cash in the Joint Account, or in the case of Money Market Funds, in
short-term money market securities. Loans through the Facility
represent similar investments of minimal credit risk which should be
consistent with these Fund's investment objectives. Municipal funds
(including Tax Managed-Balanced) do not participate in the Joint
Account since their objective is to generate tax-exempt income;
participation in the Joint Account or in the Facility as a lender is
not consistent with that objective. As such, the municipal funds and
Tax Managed-Balanced will not lend through the Facility.
Each of the Funds is subject to a fundamental limitation against
borrowing more than 15% of Total Assets for temporary or emergency
purposes. Borrowing from the Facility is consistent with this
limitation. Compliance with this limitation will be monitored on a
daily basis by the CMG.
12. The Cash Management Department will calculate total Fund borrowing and
lending demand through the credit facility, and allocate interfund loans on
an equitable basis among Funds, without the intervention of the portfolio
manager of any Fund. The Cash Management Department will not solicit cash
for the credit facility from any Fund or prospectively publish or
disseminate loan demand data to portfolio managers. The Cash Management
Department will invest amounts remaining after satisfaction of borrowing
demand in accordance with standing instructions from portfolio managers or
return remaining amounts for investment directly by the portfolio managers
of the money market Funds.
The CMG will analyze liquidity needs each morning to determine whether
it will be necessary to operate the Facility, and whether there is
sufficient anticipated cash in the Joint Account to meet borrowing
needs. Separately, the portfolio managers of the Money Market Funds
will notify the CMG of the amount of cash they wish to direct to the
Facility on a particular day. The CMG anticipates having preliminary
information regarding borrowing needs available by 8:00 AM each morning
so that the FIG can be notified as to the amount remaining to be
invested in the Joint Account. In determining the allocation of
borrowing demand among eligible lenders, we will seek to minimize the
number of loan transactions initiated, as well as minimize the inherent
risk of money movements between custodian banks. Loans will be opened
in increments of $100,000; Fund's liquidity needs will be rounded up to
the next whole increment. The CMG will first allocate loans among Funds
at the same custodian bank. This will limit the
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need to perform wire transfers among banks, thus minimizing the
exposure to errors in the process (e.g. misdirected wires, Fed wire
system failure, etc.). Loans will be allocated first to those funds
with the largest amount of available liquidity (i.e. largest Joint
Account balance). To the extent that liquidity needs cannot be
satisfied in this fashion, loans will be effected between Funds at
different custodians in such a manner as to minimize the number of
money movements and the attendant risk. Again, loans allocated in this
manner will be first assigned to those funds with the largest amount
of available liquidity. To the extent that the Money Market Funds are
not allocated any loans, the appropriate portfolio managers will be
notified so that they may invest the available funds in the market,
rather than through the Facility.
13. TVGI will monitor the interest rates charged and the other terms and
conditions of the interfund loans and will make a quarterly report to the
boards of directors/trustees of the Funds concerning their participation in
the credit facility and the terms and other conditions of any extensions of
credit thereunder.
The CMG will prepare a report for the Board on a quarterly basis for
each quarter during which the Facility operates. Additionally during
periods when the Facility is operational, VGI management (including
representation from Fund Accounting, Legal, Portfolio Management and
Portfolio Review) will meet on a daily basis to monitor the operation
of the Facility and to identify trends and/or potential issues.
14. Each Fund's board of directors/trustees, including a majority of the
independent directors/trustees: (a) will review no less frequently than
quarterly the Fund's participation in the credit facility during the
preceding quarter for compliance with the conditions of any order
permitting such transactions; (b) will establish the benchmark rate formula
used to determine the interest rate on interfund loans, and review no less
frequently than annually the continuing appropriateness of such benchmark
rate formula; and (c) will review no less frequently than annually the
continuing appropriateness of the Fund's participation in the credit
facility.
The report prepared in accordance with the preceding condition will
address each of these areas.
15. In the event an interfund loan is not paid according to its terms and such
default is not cured within two business days from its maturity or from the
time the lending Fund makes a demand for payment under the provisions of
the interfund loan agreement, TVGI will promptly refer such loan for
arbitration to an independent arbitrator selected by the board of each Fund
involved in the loan who will serve as arbitrator of disputes concerning
interfund loans. The arbitrator will resolve any problem promptly, and the
arbitrator's decision will be binding on both Funds. The arbitrator will
submit, at least annually, a written report to the boards setting forth a
description of the nature of any dispute and the actions taken by the Funds
to resolve the dispute.
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The CMG will report all defaults immediately to the Pricing Review
Committee which will ensure that all remedies provided for in the
Master Loan Agreement are exhausted. Should this not result in
immediate repayment of the loan, the matter will be referred to the
arbitrator previously selected by the Board. At its November, 1999
meeting, the Board appointed Barbara Barnes Hauptfuhrer for this
purpose.
16. Each Fund will maintain and preserve for a period of not less than six
years from the end of the fiscal year in which any transaction by it under
the credit facility occurred, the first two years in an easily accessible
place, written records of all such transactions setting forth a description
of the terms of the transaction, including the amount, the maturity, and
the rate of interest available at the time on short-term repurchase
agreements and commercial bank borrowings, and such other information
presented to the Funds' board of directors/trustees in connection with the
review required by conditions 13 and 14.
The CMG will maintain detailed documentation for each day that the
Facility operates regarding a) the inputs to the Daily Rate
determination, b) the amounts of and parties to all loans effected
through the Facility, c) any defaults
17. TVGI will prepare and submit to the Fund boards for review an initial
special report on the "Design of a system" with respect to the operations
of the interfund credit facility prior to the commencement of operations of
the facility, including a report thereon of its independent public
accountants. A test program of modest duration involving actual
transactions may be conducted prior to submission of the initial report to
the boards. An appropriate single Fund which next files its Form NSAR after
board review of the initial report will file the report with its Form
N-SAR, and the other Funds will incorporate the report by reference in
their next N-SAR filings.
Thereafter, an annual report on the "Design of the System and Certain
Compliance Tests" with respect to the accounting control procedures for
the credit facility which includes an opinion of the independent public
accountants will be filed for two years (measured from the commencement
of the facility subsequent to the test program) with the Form N-SAR of
an appropriate single Fund which next files its Form N-SAR after the
release of such annual report and opinion, and the other Funds will
incorporate each such annual report by reference in their next
subsequent Form N-SAR filings. A form of the independent public
accountants' opinion is attached as an exhibit to the application. The
initial "Design" report and the annual "Design and Compliance Tests"
report will each be prepared in accordance with the requirements of
Statement of Auditing Standards No. 70 ("SAS 70") as it may be amended
from time to time or pursuant to similar auditing standards as may be
adopted by the American Institute of Certified Public Accountants from
time to time, including reports of independent accountants thereon.
Each SAS report will include a description of the principal procedures
used by TVGI to monitor compliance with certain of the conditions the
Funds have agreed to as part of the relief requested. The principal
procedures
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described in the initial "Design" report and the annual "Design and
Certain Compliance Tests" reports will include, at a minimum,
procedures that are designed to achieve the following objectives: (a)
the Funds are required to comply with the net redemption and
percentage limitations on borrowing, and the percentage limitations on
lending; (b) the Funds are required to make loans only at the
interfund rate and such rate must be higher than the Joint Account
repurchase agreement rate but lower than the lowest daily quote rate
for available borrowing; (c) the Funds are required to allocate
borrowing and lending demand in accordance with procedures established
by the boards of directors/trustees; (d) if a Fund, at the time of its
borrowing from a Fund, also has outstanding third-party borrowings,
the interest rate on such interfund borrowing cannot exceed the
interest rate on third-party borrowings; and (e) the Funds are
required to pledge collateral for interfund loans when and to the
extent provided by the conditions to any order issued on the
application. Each annual SAS 70 report will consider compliance with
the procedures designed to achieve the foregoing objectives. After the
final annual SAS 70 report, compliance with the conditions to any
order issued on the application will be considered by the external
auditors as part of their internal accounting control procedures,
performed in connection with Fund audit examinations, which form the
basis, in part, of the auditors' report on internal accounting
controls in Form N-SAR.
This document in its entirety constitutes VGI's representations to the
Board with regard to the design of our system of procedures and
controls surrounding the operation of the Facility. VGI will obtain
from its independent accountants (PriceWaterhouseCoopers) an initial
SAS 70 covering the adequacy of the controls and procedures to ensure
compliance with the Order.
18. No fund will be permitted to participate in the Credit Facility upon
receipt of requisite regulatory approval unless the Fund has fully
disclosed in its prospectus all material facts about its intended
participation.
Each of the member funds of the Vanguard Group has obtained approval
from its shareholders to participate in the Facility and has disclosed
its potential participation in its prospectus or Statement of
Additional Information. Additionally, the Vanguard Institutional Index
Fund and the Vanguard STAR Fund, although not members of the Group, are
also covered by the exemption and have obtained the requisite approvals
and made the required prospectus disclosures.
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