Chapter 7. Operational Issues in Establishing a Primary Dealer System

Marco Arnone, and Piero Ugolini
Published Date:
February 2005
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This section will cover specific operational issues to be addressed in setting up a primary dealer system—namely, selection criteria, obligations, privileges, supervision, and the issue of foreign firms. Also, legal arrangements will be discussed in some detail.

In addressing issues related to obligations and privileges, the mix should be designed in the context of the development needs of the market and the participants. The obligations that primary dealers establish are the commitments they make to perform certain activities; their “privileges” are those arrangements that should allow the primary dealers to perform those functions efficiently, often in the absence of other supporting market infrastructure. Together they form an integral part of the overall development strategy in developing emerging market economies. More specifically, the mix of obligations and privileges of primary dealers, together with the commitments of the authorities to specific objectives and strategies, should be focused on the development needs of the market and the issuers’ and participants’ requirements.

There are also issues of design and coordination of the PD system: it is possible for the central bank and the debt manager to design the PD system to meet the needs of both the central bank and the issuer. From a functional viewpoint, one should distinguish primary dealers in the market for government securities from primary dealers for central bank operations. These two functions are theoretically separated, but operationally the same institutions might be awarded both roles, depending on the institutional arrangement.

Some countries establish separate tiers of dealers that focus on different functions. For instance, Canada has a separate category of “primary distributors” compared to “jobbers,” which have a more market-making requirement. India has primary dealers and satellite dealers, with the latter group having a lower capital requirement than primary dealers. In Italy, primary dealers are required to take up stock in the auctions, while market makers are, in addition, required to provide two-way quotes. Thus, countries may decide to extend the general approach to responsibilities by establishing different tiers of dealers, with each tier having separate requirements and objectives. This approach could be particularly useful if there is a need to develop a potentially large retail sector when there are a relatively limited number of large, well-capitalized institutions.

A. Selection Criteria

The selection criteria for primary dealers should be related to the role that they are expected to play in the primary and secondary markets for government securities and should contribute to the overall stability of the financial system. These criteria will also influence the number of participants and the degree of competition in the markets for government securities and the ability of the selected institutions to sustain an active market. The following selection criteria represent an indicative, but by no means exhaustive, list, depending on a country’s degree of economic development and market sophistication.

The first and most important criterion is financial capacity, usually expressed in terms of net capital or own funds. There can be minimum capital entry levels, with higher required amounts reflecting the actual or prospective market share. There are a number of reasons for the importance of financial capacity. First, it is a measurable criterion, so all applicants for the role of primary dealer can be assessed against it. Second, a minimum capital requirement should guarantee that the institutions have sufficient financial capacity to undertake an active role in both the primary and secondary markets, giving them depth and continuity. Third, financial strength helps to build confidence in the market. Fourth, it restricts the function of primary dealers only to the soundest institutions, limiting the risk of future financial problems of primary dealers. Also, it means that primary dealers can withstand setbacks and still meet their obligations.

Additional specifications related to the financial soundness requirement can also be required. For instance, they can include (1) setting aside a certain amount of capital to be used exclusively for dealing with government securities; (2) creating a legal entity with separate capitalization; and (3) a commitment of the parent financial institution to support the subsidiary in case of lack of capital or forthcoming failure.

In most industrial countries with PD systems, banks themselves can act as primary dealers, without establishing a separate legal entity. However, some countries, particularly developing countries, require a bank that is also a primary dealer to establish a separate subsidiary or legal entity for its PD activities. For example, in India, while banks can undertake securities dealing, they are required to set up separate subsidiaries to be registered as primary dealers. Also, Sri Lanka first required that primary dealers be separately capitalized subsidiaries, but that changed recently and now banks can act directly as primary dealers. However, capital is still to be dedicated to that business line. While strategies may differ among countries with primary dealers, the most important thing is that the risks are covered and the businesses are professionally managed. Whether, from a regulatory perspective, one needs to do this in a separate subsidiary may depend on country circumstances and stage of development. However, requiring separate subsidiaries does involve significant costs, which need to be weighed against regulatory and strategic benefits.

A second criterion is market activity. Financial institutions aspiring to the role of primary dealer with the public debt manager or the central bank must be active in the primary market at auction times, tap sales, and syndications and in the secondary market with placement of securities among the public and their own clients’ base. Measures of market activity might include the average share of securities in the primary market, and the trade volume and average share of securities in the secondary market. The demonstrated activity need not be at the required level immediately after the appointment to PD status, but this requirement must be fulfilled at the time of the first review.

Management capacity and suitable technological infrastructure is a third criterion. The applicant must have the expertise to sustain an active and efficient market for government securities. Creating separately capitalized subsidiaries for this purpose can facilitate the creation of new incentive mechanisms and career streams outside the traditional roles of banks’ personnel management, especially in emerging markets, channeling to the new firm professional expertise and good dealers. This means, for instance, having a minimum number of experienced traders. A minimum number can be established by the authorities depending on local conditions. In addition, a potential primary dealer must have the technological infrastructure to support government securities trading, with the central bank, with other banks, and with the public at large.4 This can take several forms depending on local technological conditions and the requirements of the authorities, including at least standard technology for submitting bids at primary auctions, the secondary market trading technology in the wholesale and retail segments, and access to a primary dealer-wide depository system.

Relations with the authorities must be current practice at several levels.5 A first and more immediate level is the supervisory responsibility. The supervision of the prospective primary dealer should be such as to leave no doubt that the institution is sound, well managed, and well equipped for its present and future role. A second and less immediate level concerns the exchange of information with the relevant agencies, especially the debt manager and the central bank, regarding daily activity in volume and type of instruments in the interbank market and with the public at large. A third level concerns informal exchanges of information, practitioners’ opinions on strategies and development, and providing the government with information about market conditions. This requires building a relationship of institutional trust and respect, beyond the simple exchange of information.

Other selection criteria can also be used depending on specific characteristics and development of the domestic financial market and of the country. The authorities might consider making the following efforts:

  • impose a minimum threshold for credit rating, which would increase public confidence;
  • require a track record in other developed bond markets, for institutions already active in other markets or other countries;
  • require affiliation to a domestic association of dealers, for supervisory purposes; and
  • require that core trading and sales operations for government securities of foreign banks be undertaken in the country.

A minimum threshold for capital and involvement in the government securities market are the most commonly reported selection criteria for primary dealers. These are minimal requirements, although often other criteria are specified. Good distribution and placement capacity is a specific requirement in Belgium, Ireland, and Italy. Other requirements tend to complement the previous ones and are generally country specific. For instance, Thailand requires primary dealers to have a risk management system in place and coordination with the authorities for the development of the secondary market, while Singapore requires a minimum credit rating, at least two experienced dealers, and a good track record in other developed bond markets. Britain and Ghana require primary dealers to be members of the stock exchange.

In general, the institutions that fulfill the requirements are appointed primary dealers, but an alternative has been developed that fixes the number of dealers, and rotates primary dealers. For example, in October 2000, Mexico introduced a PD system with an original selection and rotation procedure—allowing only five institutions as primary dealers to be appointed every six months. At the end of the period, existing dealers would be ranked according to performance, with the worst performer leaving the group and a new institution replacing it as a primary dealer. The performance criteria for commercial banks and brokerage houses (the only institutions allowed to become primary dealers) are based on volumes of activity in government securities. An index measures activity in the primary market, in the interbank market, and at retail level. Every six months, the institutions with the highest score become primary dealers; if they are the same as in the previous period, the last one is eliminated and the first among the nonprimary dealers becomes a primary dealer. These procedures reduce the incentive for dealers to collude, while also presenting barriers to entry.

The first two criteria are the most widely used and all countries in this study apply them. Table 1 provides a list of the existing selection criteria as reported by the 39 countries surveyed for this study, and Table 2 provides a number of country examples.

Table 1.Selection Criteria for Primary Dealers
Active involvement in government securities market.
Minimum capital.
Placement capacity.
Conformity in fulfilling all requirements set by the central bank for the commercial banks.
Long-term commitment to market development.
Dealers on the Stock Exchange.
Efficient bond trading.
Participation in money market.
Affiliation to the association of dealers.
Core trading and sales operations for government securities resident in the country.
Minimum credit rating.
Established presence in the country.
Staffing requirements and professional skills.
Performance recording of other developed bond markets.
Guarantee for the physical and financial settlement of bonds.
Rotation of primary dealer based on performance among a larger group of banks.
Source: IMF staff survey of national authorities (2001).Note: The ordering of the items indicates the frequency—from higher to lower—of each reported item. The list of items reported shows some countries’ practices and should not be interpreted as recommended.
Source: IMF staff survey of national authorities (2001).Note: The ordering of the items indicates the frequency—from higher to lower—of each reported item. The list of items reported shows some countries’ practices and should not be interpreted as recommended.
Table 2.Selection Criteria for Primary Dealers—Selected Country Experiences
Advanced Countries
AustriaInvolvement in government securities market, placement power, and efficient bond trading.
BelgiumInvolvement in government securities market and placement capacity.
CanadaMinimum capital and involvement in government securities market. Primary dealers must be Government Securities Dealers, who in turn must (1) be members, or affiliates of members, of the Investment Dealer Association of Canada; and (2) have their core trading and sales operations for government of Canada securities resident in Canada.
FinlandMinimum capital, involvement in government securities market, and long-term commitment.
FranceMinimum capital and involvement in government securities market.
GreeceMinimum capital and involvement in government securities market.
IcelandMinimum capital and involvement in government securities market.
IrelandMinimum capital, involvement in government securities market, and ability to distribute Irish government bonds.
ItalyMinimum capital and involvement in government securities market. Primary dealers must have an organization suitable to obtain a widespread and efficient placement of securities.
NetherlandsMinimum capital, involvement in government securities market, and geographical distribution of their turnover and promotion activities, along with commitment to place securities.
NorwayInvolvement in government securities market.
PortugalInvolvement in government securities market and Regulation No. 1/2001, Art. 6 and 16:

- capacity for subscription and placement of bonds in the competitive phase of auctions;

- regular and significant participation in the secondary bond market;

- ability to offer guarantees for the physical and financial settlement of bonds;

- production of a statement signed by the dealers’ Board of Directors, in which they pledge to obey the rules of the Regulation.
SingaporeInvolvement in government securities market, minimum credit rating, staffing requirements of at least two dealers with experience in fixed-income trading, along with a track record in other developed bond markets.
SpainInvolvement in government securities market.
SwedenMinimum capital and involvement in government securities market.
United KingdomInvolvement in government securities market. Dealers must be members of the London Stock Exchange and produce a business plan; also must be subject to Financial Services Authority approval.
United StatesMinimum capital and involvement in government securities market (although there is no specific requirement as to the extent of involvement). The institution cannot have been convicted of a felony crime.
Developing Countries
ArmeniaMinimum capital and involvement in government securities market. All institutions should meet all requirements established by the central bank for commercial banks, because all primary dealers are commercial banks.
GhanaInvolvement in government securities market. All dealers must be on the Ghana Stock Exchange in the case of brokerage firms, and must be Deposit Money Banks, with reserve requirements already met.
MoroccoInvolvement in government securities market, minimum volume of subscription on the primary market, and minimum traded volume on the secondary market (10 percent).
Emerging Markets
ArgentinaMinimum capital and involvement in government securities markets.
BrazilMinimum capital, along with compatibility with the minimum capital requirements of a commercial bank; involvement in government securities primary and secondary markets; capability to remain market makers; participation in open market operations; and relationship with the central bank trading desk.
Czech RepublicMinimum capital and involvement in government securities market, together with minimum obligations on government bonds and bills.
HungaryMinimum capital, involvement in government securities market, and right to trade on the Budapest Stock Exchange.
IndiaMinimum capital and involvement in government securities market.
KazakhstanMinimum capital and involvement in government securities market.
KoreaMinimum capital and involvement in government securities market.

B. Obligations

The delicate role of primary dealer entails explicit or implicit obligations, with the general goal of developing, supporting, and stabilizing the primary and secondary market for government securities. In many cases, the authorities establish privileges for the primary dealers, not only as a reward for their function, but also to motivate primary dealers to perform their functions efficiently and in a cost-effective way.

Obligations Related to the Primary Market

The primary dealer’s first obligation is that of underwriter of government securities, a clearly defined function, which takes place in an auction or in another selling arrangement (e.g., direct sale or syndication). The authorities may select various criteria for the primary dealer to fulfill this obligation, which include average amounts underwritten and the minimum bid size.

In this first case, the minimum commitments of the primary dealer can be specified in terms of average amounts underwritten at the auctions in a certain time span.6 This number could be specified as total amounts of securities or as the average size of underwriting for different categories of securities. With this latter option the authorities might encourage specialization, but the chance for this to happen depends entirely on the degree of market development and sophistication. A second possible specification of this criterion would be to impose a minimum bid per auction as a proportion of the total amount tendered. In this case, the authorities must carefully evaluate the level of the minimum threshold:7 setting it too low generates the risk of a shortfall in underwriting, while setting it too high—for example, such that the total bids are always far above the maximum tendered amount—might strain the financial capacity of the primary dealer.

In case the design allows for a random shortfall in underwriting at auctions, rules should be set as to the maximum size of random shortfalls that primary dealers are required to cover. When planning to introduce a PD system, a careful analysis should be undertaken of the likelihood and size of possible shortfalls, trying to establish an expected value of the shortfall. From this value, it would be simple to derive the minimum amount of net-free capital necessary to undertake this function.

Whichever specification of the criterion is chosen, the authorities must always balance the need of securing a suitable time horizon for the supply of liquidity against the banks’ liquidity management needs: too stringent requirements that might generate excessive average holding of government securities could, in turn, undermine primary dealers’ abilities to support the government in the long term. Excessive average holding cannot be defined ex ante because it depends on many factors, including the secondary market liquidity conditions, the demand for specific bond issues and maturities, and the availability of alternative financial instruments.

A different but related issue pertains to participation in auctions: evidence suggests that both open and closed auction formats exist in PD systems. While expanding participation beyond the primary dealer group might increase the chances of competition and underwriting, it may also dilute the incentive structure for primary dealers. Typically, the decision as to whether to have an open or closed auction is likely to rest on the issuer’s requirements. For example, closed auction systems are most often associated with PD systems that call for the dealer to provide a good deal of underwriting support to the auction. The debt manager should be prepared to trade off more predictable coverage for possibly a higher average cost. It follows that, in deciding on the design of the system, primary auctions might be closed if primary dealers are required to provide underwriting support. On the other hand, if underwriting is not required, then auctions might be more open, and only a general commitment to bid by primary dealers might be required.

There are also instances in which expanded participation might generate problems in small and less-than-well-developed financial markets: for example, in multiple-price auctions, when large (compared to the average primary dealer size) institutional investors, like public pension funds or public health insurance companies, are allowed to participate, these institutions can be easily induced by the authorities—in an attempt to minimize government’s borrowing cost—to bid at a low price, thereby acquiring a large proportion of the tendered amounts and blurring price discovery and competition. Therefore, at an early stage of the implementation of the PD system, the authorities might wish to assess the pros and cons of allowing large players in the primary auctions or of directing them to the secondary market. In the former case, the presence of large institutional investors at the primary auction should be specifically addressed in the primary auction design—for example, by limiting large institutional investors to noncompetitive bids, or adopting a uniform price auction. Also, the system should allow for indirect bidding (pretenders). The handling of orders through indirect bidding is generally done at very low or no cost.

Operationally, the issue of what group of institutions should be allowed to participate in the primary market will have to be determined in each country, taking into account, at least, some general principles: transparent selection rules and procedures, avoiding unfair advantages to the participants to the disadvantage of outsiders, coordinated supervision, ascertained financial and technical capabilities, and degree of sophistication of the domestic financial firms, in terms of financial instruments available and participation in various market segments.

In the agreement with primary dealers, the authorities might establish the right to reopen the issue of a specific security and sell at short notice, say one day, in auctions open to the primary dealer only, should the government find itself with an unexpected liquidity shortage. In these cases, the agreement should only require primary dealers to provide bids, but should not impose an underwriting obligation.8

Finally, since one of the functions of primary auctions is to allow for price discovery so that the financing/liquidity/operational needs of the government can be met in the market, an auction allocation can take place only in a liberalized interest rate environment, with auction rules clearly supporting a competitive environment, while providing the primary dealers enough compensation for the underwriting obligation.

Obligations Related to Market Making and the Secondary Market

The secondary market can be distinguished in two segments: the wholesale market where financial institutions trade among themselves, and the retail market where financial institutions place government securities with retail investors. The liquidity and investment needs in the two segments can be quite different. Consequently, the authorities are in a position to negotiate different obligations for the same financial institution in the different segments. Also, the mix of obligations must be tailored to the overall market architecture; if secondary quote making is to be the centerpiece of the system, then firm quotes, holdings of inventories, and adequate turnover may be the key markers of the system.

A special type of function in the secondary market that primary dealers are sometimes called on to perform is to serve as counterparties to the monetary authority in its conduct of open market operations—buying and selling government securities, either outright or through repurchase agreements for the purpose of managing bank liquidity. In many countries, one of the incentives for being a primary dealer is to be included in the group of exclusive counterparties with the central bank in its open market operations. In a few countries, such as France and Sweden, two different groups of specialized intermediaries are selected: one to serve as exclusive counterparties for the central bank in conducting its open market operations, and the other group to support the primary market and operate as market makers in the secondary market. Poland, on the other hand, has a group of dealers selected to serve as counterparties for the central bank in its open market operations; but it has no primary dealer system for government securities.

In the wholesale market, another important general obligation is to provide liquidity in the market for government securities by ensuring a continuous trading presence. How stringent this condition is depends on circumstances related to government financing needs and the financial strength of primary dealers, from a minimal condition on presence in the market to specific conditions about quotes; this means that the provision of liquidity cannot be taken for granted.

Quotes on securities can be required to be two-way or not: they can be indicative or firm, and they can cover the entire range of benchmark issues, depending on the overall market architecture. A firm, two-way quote means that the primary dealer stands ready to buy and sell at the quoted prices a predetermined amount of securities. If the quote is indicative, it means that the financial firm has no obligation to buy or sell at that price. This can happen for several reasons—for example, in extremely thin markets or for nonbenchmark securities, the quoted price might be only notional and there might be no actual purchases or sales at that price; alternatively, the firm might want to retain price flexibility.9 Quoting two-way prices and engaging in block trades in the secondary market can be key obligations for primary dealers related to market making, and imposing firm, two-way quotes may be a major requirement for primary dealers. In general the commitment of firm quotations is an integral part of the overall market architecture. In a number of countries—the Italian Mercati Titoli di Stato electronic system, for example—the commitment to bid is at the center of the electronic dealer system, where primary dealers are market makers. Hence, those countries that focus on a system of market makers would likely have a PD system with an obligation to quote firm prices.

The size of the spread between bid and asked prices reflects risks, operational costs, and possibly some dealer rents. The spread should be market determined and sufficient to induce participation, but at the same time it should not be so large as to indicate monopoly profits.

The authorities should also agree with the primary dealers on whether they require quotes on the whole range of securities or only on benchmarks. In this latter case, the authorities will define the benchmarks and the selection process for new benchmarks when issued. The authorities might induce specialization of the primary dealer by requiring quotation on certain issues or maturities. However, while requiring quotation of benchmarks is a standard requirement, requiring selected quotations should be handled carefully: in emerging markets certain segments of the government securities market can be very thin, so the primary dealers might face large demand swings or find themselves with a rather illiquid portfolio of securities. At first, the authorities should aim at overall support for government securities; only much later, a higher degree of sophistication could be required from primary dealers and investors, by moving toward specialized market segments.

The authorities might also require that primary dealers develop a significant presence in the retail market, if there is a perception that government securities might be in demand. The requirement that primary dealers operate also in the retail market (made up of smaller customers, generally individuals) is probably taken for granted in industrial countries and some emerging market countries, but in several developing countries this is an issue the authorities need to analyze thoroughly before imposing primary dealers’ obligations in this segment of the market. Operating in the retail market significantly increases costs for the primary dealers because the physical infrastructure for the provision of this service to the retail investor must generally be provided by the primary dealers. Consequently, the spread is usually larger in the retail market and the authorities might impose a limit on the divergence of the retail market spread from the wholesale market one. Again, the size of the spread must balance this increased cost with the need to avoid an unfair advantage for primary dealers. Reporting obligations10 to the supervisory authority (ministry of finance, central bank, other agencies responsible for public debt management, securities and exchange board, stock exchange) are typically part of the primary dealer’s agreement. Such an agreement usually includes reporting on market conditions, as well as on the primary dealer’s operations (see Section E, “Supervision,” below), and helps to evaluate developments in the market and in individual institutions. Given the large number of authorities interested, a division of reporting obligations should be clearly agreed upon, to avoid duplication. Other obligations that some countries have imposed include participation of primary dealers in calculating the local currency interbank rate and in providing government securities closing prices, as in the case of Singapore.

In enforcing these obligations in both the primary and the secondary market, there are some practical issues to be considered: in the case of developing countries, the authorities should also take into account the structural and operational difficulties that primary dealers might encounter in supporting the government or the central bank. Particular care should be taken to ensure that the secondary market actually develops, meaning that the authorities should not be too strict in requiring, for instance, narrow spreads or large transaction size. At the initial stages of implementation, the market tends to be highly volatile, increasing the risk of making losses, so primary dealers might need to be flexible on spreads and transaction size. Moreover, in the primary market, auctions might go undersubscribed, depending on the auction design: in this case the authorities should carefully evaluate whether to oblige primary dealers on subscribing to the residual part and they should certainly try to avoid selling at a lower price after the auction, because this would result in both an immediate loss for those who have bought at the auction and a loss of credibility for the institutional arrangement of the auction. Moreover, if the authorities are trying to develop the retail market, they should try to support primary dealers’ efforts and limit their involvement in retail activity.

All countries surveyed reported that primary dealers must be active in the primary auctions, but while some, such as France, Portugal, and India, have a specific obligation to subscribe to a certain minimum percentage of auctioned securities, the majority of countries did not report specific underwriting obligations.11

Among the advanced economies in the survey, Belgium, Canada, Finland, France, Iceland, Ireland, Netherlands, Portugal, Singapore, Spain, and the United Kingdom require their primary dealers to have firm two-way quotes; Greece and Italy require only two-way quotes. Among emerging market economies in the survey, India and Mexico require firm two-way quotes; Hungary and Thailand impose two-way (but not necessarily firm) quotes; Argentina, Czech Republic, and Kazakhstan impose firm (but not necessarily two-way) quotes. Among developing countries surveyed, only Morocco imposes firm two-way quotes, while Armenia has two-way only and Ghana imposes firm quotes.

In several advanced economies, the requirement of being active in the secondary market, both wholesale and retail, is included in the selection criteria, but in other countries, where the government is developing the market for government securities, supporting market development can be a specific obligation, like it is in Argentina, Czech Republic, and Korea.

Table 3 provides a list of the existing obligations of primary dealers as reported by the 39 countries surveyed for this study, and Table 4 provides selected country experiences.

Table 3.Survey of Obligations of Primary Dealers
Bid in the auctions.
Quotation firm/two ways.
Reporting to the supervisory agency (central bank, ministry of finance, and/or other).
Providing the authority with market information and analysis.
Promotion of the debt among retail investors.
Specified percentage of the deposits in government securities held to meet secondary reserve requirement.
Minimum underwriting obligation, per unit of time or in terms of turnover.
Assisting in the development of the government securities market.
Participating in the fixing of interbank rates.
Providing government securities closing prices.
Participation in money market operations.
Compliance with prudential regulation.
Participation in research.
Source: IMF staff survey of national authorities (2001).Note: The ordering of the items in Table 3 indicates the frequency—from higher to lower—of each reported item. The list of items reported shows some countries’ practices and should not be interpreted as recommended.
Source: IMF staff survey of national authorities (2001).Note: The ordering of the items in Table 3 indicates the frequency—from higher to lower—of each reported item. The list of items reported shows some countries’ practices and should not be interpreted as recommended.
Table 4.Obligations of Primary Dealers—Selected Country Experiences
Advanced Countries
AustriaTo bid in the auctions and to make firm quotes.
BelgiumTo bid in the auctions; to make firm, two-way quotes; to report to the central bank; and to promote the debt.
CanadaTo bid in the auctions; to make firm, two-way quotes; to report to the central bank; and to adhere to the obligations indicated in the Terms of Participation in Auctions for Government of Canada Securities Distributors. Also, all Government Securities Dealers (and by design, primary dealers) must agree to comply with Investment Dealer Association Policy No. 5, the Code of Conduct.
FinlandTo bid in the auctions; to make firm, two-way quotes; to report to the central bank; and to sponsor the Finnish debt.
FranceTo bid in the auctions; to make firm, two-way quotes; to report to the Treasury; to perform an advisory role; and to promote the debt.
GreeceTo bid in the auctions and to make two-way quotes.
IcelandTo bid in the auctions and to make two-way quotes.
IrelandTo bid in the auctions; to make firm, two-way quotes; and to report to the National Treasury Management Agency.
ItalyTo bid in the auctions and to make two-way quotes. On the secondary market, only proposals for a minimum of five hours a working day will be taken into consideration. Consideration is also given to the bid-ask spread, number of securities treated and quoted, total amount exchanged, and comparison with other applications.
NetherlandsTo bid in the auctions; to make firm, two-way quotes and to report secondary market turnover to the Dutch State Treasury Agency (DSTA); to act in the interest of the DSTA; and to participate in research.
NorwayTo make firm, two-way quotes and to report to the central bank.
PortugalTo make firm, two-way quotes. Regulation No. 1/2001, Art. 18, also requires dealers to

- bid regularly under normal market conditions and subscribe to a share not lower than 2 percent of the amount placed at the competitive phase of the auctions;

- participate actively on the secondary market, ensuring liquidity;

- participate as market maker, with no less than 2 percent of the market’s turnover share;

- keep a permanently updated page showing quotations for liquid treasury bonds in a specialized remote information system of widespread dissemination;

- supply the information required for the monitoring of their activity in the secondary market and to check compliance with the provisions of this regulation;

- respect all rules adopted by the Institute for Public Debt Management (IGCP) regarding the scope and object of the Regulation;

- operate as privileged consultants to the IGCP in the monitoring of financial markets;

- recommend improvements to the IGCP regarding any difficulty in performing some of the duties, namely in case of anomalous or extraordinary market conditions, and await the IGCP’s consent of the change in the form of compliance, or of noncompliance, with any of the duties.
SingaporeTo bid in the auctions, to report to the central bank, to provide liquidity in Singapore Government Securities (SGS) outright and to repo markets by making two-way quotes, to participate in SGS auctions and underwrite issued securities, to give feedback to the Monetary Authority of Singapore, to assist market development, to help fix interbank rates, and to provide closing prices.
SpainTo bid in the auctions; to make firm, two-way quotes; and to provide any information required by the Spanish Treasury concerning the public debt market and the primary dealer’s trading activity in the market. Market makers are requested to send a monthly report about their activity in the primary and secondary markets.
SwedenTo bid in the auctions, to report to the central bank, and to contribute with good liquidity in the market.
United KingdomTo make firm, two-way quotes with no obligation to quote to other primary dealers; to report to the central bank; and to report trades to the London Stock Exchange.
United StatesTo bid in the auctions, although the obligation to bid in the auctions is not contractual and the primary dealers are not necessarily expected to participate in every auction; to report to the central bank; to participate in the Federal Reserve’s open market operations and other business activities, and to provide the Federal Reserve with market information and analysis.
Developing Countries
ArmeniaTo bid in the auctions with noncompetitive bids of less than 1 percent of the total issue; if dealers’ noncompetitive bids exceed 1 percent, their competitive bids should be five times higher than the noncompetitive bids. Primary dealers are also responsible for making two-way quotes and reporting to the central bank.
GhanaTo bid in the auctions, to make firm quotes, and to report to the central bank. The banks must also hold a specified percentage of their deposits in government securities to meet the secondary reserve requirement.
MoroccoTo bid in the auctions and to make firm, two-way quotes.
Emerging Markets
ArgentinaTo bid in the auctions, to report to the central bank, to make firm quotes, and to maintain a minimum market share in the secondary market.
BrazilTo bid in the auctions and to report to the central bank.
Czech RepublicTo bid in the auctions, to report to the central bank, to make firm quotes, to underwrite quarterly a certain amount of government bonds, and to order a certain amount of treasury bills each quarter.
HungaryTo bid in the auctions; to make firm, two-way quotes; and to report to the government debt agency.
IndiaTo bid in the auctions; to make firm, two-way quotes; and to report to the central bank.
KazakhstanTo make firm, two-way quotes; to report to the central bank; and to maintain a “normal” position according to Kazakhstan’s prudential norms.
KoreaTo bid in the auctions, to make two-way quotes, and to trade a minimum of 2 percent of total secondary market volume.
MexicoTo bid in the auctions, to make two-way quotes, and to report to the central bank.
ThailandTo make two-way quotes.
Source: IMF staff survey of national authorities (2001).
Source: IMF staff survey of national authorities (2001).

C. Privileges

Primary dealers may enjoy privileges or supporting arrangements arising as a counterpart to the obligations they assume; and they may benefit from other privileges related to the role itself. As a counterpart to the obligations that financial institutions assume in their role as primary dealers, they might enjoy some privileges in the primary and in the secondary market for government securities, as well as in their relationship with the authorities. The overall mix of privileges and supporting arrangements depends on the overall market architecture. The extent and design of these privileges should vary depending on the weight of the obligations and their definition, and on the authorities’ objectives. In particular, the privileges may be more like supporting arrangements that allow the primary dealers to perform their functions efficiently and to meet specific objectives of the authorities for market development. The extent and limitations of the privileges should also form part of the agreement with the authorities. The privileges that primary dealers are granted in the agreement can be seen as obligations for the authorities.

Other privileges and advantages are instead related to the role of primary dealers itself. This occurs because a formal (or informal) agreement with the authorities in support of liquidity needs of primary dealers by developing a securities market certainly confers a certain status on these financial institutions and enhances their credibility as sound agents with strong financial expertise. Moreover, primary dealers might derive an informational advantage by meeting regularly with the central bank or the ministry of finance. However, authorities should be especially careful not to provide market-sensitive information to primary dealers and not the general market, or otherwise violate competitive neutrality, especially with regard to information that could affect interest rates and market price, budget forecasts, and buyback plans. The most important type of information that primary dealers should be able to build on is the order flow in the market.

The authorities might decide to pay a commission for the services rendered by the primary dealers, but in doing so the authorities should not be providing a subsidy for the activity of the primary dealers. Commissions could be fixed or negotiated, but if they are put in place, they should be negotiated as part of the system. For instance, India has a pre-auction, which sets the size of the underwriting commitment and the commission for that commitment.

In the primary market, the most important privilege is related to the degree of exclusivity of access. Different forms are possible and not necessarily mutually exclusive:

  • The strongest privilege is exclusive rights to bid at auctions. While such a format helps to ensure that participants are financially and technically strong, it can lead to collusive behavior when the number of primary dealers is small. This requires a careful choice in granting such exclusivity and careful supervision. The following countries have granted primary dealers an exclusive right to bid at primary auctions: Austria, Belgium, Czech Republic, Finland, Ghana, Greece, Iceland, Ireland, Hungary, Kazakhstan, Republic of Korea, Netherlands, Singapore, Sweden, and the United Kingdom.
  • A weaker form of privilege is the exclusive right to bid at “second round” sales. Two cases can be distinguished; first, in situations in which there is underbidding or a shortfall at the auction, primary dealers can intervene to buy the remaining part; second, a specific amount can be set up in advance12 for the primary dealers so that they have exclusive rights only on part of the auctioned securities, but are in competition with other institutions for the remainder. In general, the noncompetitive allocation is based on the average auction price of the competitive round. This privilege is granted in Argentina, France, Mexico, Portugal, and Spain.
  • Primary dealers can be given exclusive rights to participate at tap sales, that is, for specific issues of government securities, as is done in Italy.

Other advantages in the primary market might include the following:

  • Exemption from the requirement to submit payment at the time of bidding.
  • The right to submit bids closer to the cutoff time, for example, by telephone or by any automatic remote link. This right can confer a substantial commercial advantage over competitors.
  • Exclusive access (for dealing only or for dealing and viewing) to the screens of inter-dealer brokers. This might help primary dealers assess the price at which to bid at auctions.

Additional advantages are related to the secondary market:

  • Access, sometimes exclusive, to the trading system of inter-dealer brokers. Because only dealers trade on this system, primary dealers can take on or unwind positions without disclosure knowing the approximate credit rating, that the counterparty in any trade will be another primary dealer, and that the trade will be honored. This allows primary dealers to actively manage their positions.
  • Accessibility to a broader set of operations than for other traders. Particularly relevant is the option to borrow stock and to take short positions, to facilitate their market-making function.
  • The privilege of becoming the exclusive counterparty for operations with the public debt manager, an opportunity granted in Argentina and Belgium.

In their relationship with the central bank, primary dealers may also enjoy additional privileges or supporting arrangements that permit them to carry out their functions more effectively:

  • The central bank might grant primary dealers in the market for government securities exclusive counterparty status in its monetary policy operations. In this case, the primary dealers secure a privileged position in both government securities and money markets. The following countries grant such a privilege: Armenia, Brazil, Canada, Ghana, India, Singapore, Thailand, and the United States.
  • Primary dealers might have access to a short-term facility from the central bank on a secured basis, if market financing is not readily available, subject to maximum amounts related to the borrower’s capital. The following countries grant such a privilege: Canada, India, and Mexico.
  • Primary dealers might be supported by having the privilege to obtain stock (possibly, through repos) from the authorities, if their own portfolios lack relevant stock, or market-making obligations have left the primary dealers short of specific stock. From a market architecture point of view, countries that have poorly developed or segmented funding markets would have substantial lines available to help facilitate the dealer’s market-making function. This facility is available to primary dealers, for instance, in Ireland, Mexico, Singapore, and the United States.

Indeed, a privileged relationship with the debt manager can give the primary dealers status in the financial community. In addition, these institutions can expect to be consulted from time to time on issues related to market development, market structure, market infrastructure, regulatory procedures, and code of conduct, or operational issues like market desire for specific issues or maturity structure.

Another important privilege or supporting arrangement that should be carefully designed is the provision of liquidity facilities to primary dealers: provision of liquidity, in addition to the market and the usual standing facilities available to all banks, should be at market rates or slightly above that level, and departures from this principle should only be motivated by exceptional reasons. This would show that the central bank is supporting the primary dealers’ market-making role without distorting price signals from the market. A delicate aspect of the relationship concerns the support primary dealers can receive from the debt manager for the central bank or the ministry of finance with respect to making available stock from its own portfolio, usually through repos, at a cost that should not amount to a subsidy to the primary dealer and should not undermine the interbank market.

In applying these conditions to developing countries, a careful assessment of the privileges and supporting arrangements should be made. For example, granting exclusive bidding rights at auction can be of little relevance in an infant financial market with only a handful of banks. However, as the financial market grows, excluding some agents from auctions can give enough incentive to primary dealers to continue in their role, while at the same time helping build a secondary and retail market. Therefore, the potential disadvantage of having a more limited number of players should be weighed against the advantage of stimulating more effective players on the secondary and retail markets. If, however, the authorities decide to extend participation to institutions other than banks, settlement and supervisory problems may arise that have to be addressed before the system becomes operational.

Table 5 provides an indicative list of the existing privileges granted to primary dealers, as reported by the 39 countries surveyed for this study; and Table 6 provides selected country experiences.

Table 5.Survey of Privileges of Primary Dealers
Exclusive or privileged access to primary auctions.
Exclusive or privileged counterparty for central bank’s open market operations.
Exclusive or privileged access to noncompetitive bids.
Information from and consultation with the government debt management agency.
Borrowing privileges with central bank, including repurchase agreements.
Exclusive or privileged counterparty for operations with public debt manager.
Participation in a second round of primary auctions.
Underwriting commissions.
Usage of the title “primary dealer.”
Extra time to submit bids at bond auctions.
Privileged counterparties of the government debt issuer in other instruments (such as swaps and foreign currency issues).
Tax exemption on securities trading income.
Authorization to bid for the entire issue, while other dealers can bid only for part of the issue.
Exclusive access to stripping and reconstitution of bonds.
Preference in the formation of syndicates and in other forms of placement of government debt.
Source: IMF staff survey of national authorities (2001).Note: The ordering of the items in Table 5 indicates the frequency—from higher to lower—of each reported item. The list of items reported shows some countries’ practices and should not be interpreted as recommended.
Source: IMF staff survey of national authorities (2001).Note: The ordering of the items in Table 5 indicates the frequency—from higher to lower—of each reported item. The list of items reported shows some countries’ practices and should not be interpreted as recommended.
Table 6.Privileges of Primary Dealers—Selected Country Experiences
Advanced Countries
AustriaExclusive access to primary auctions with noncompetitive bid option.
BelgiumExclusive access to primary auctions and counterparty for operations with the Treasury.
CanadaExclusive counterparty rights for central bank’s open market operations and borrowing privileges with central bank.
FinlandExclusive access to primary auctions and to the Treasury’s repo facility.
FranceRegular meetings with the Treasury; most frequent but not exclusive counterparty of the Treasury.
GreeceExclusive access to primary auctions and to liability management.
IcelandExclusive access to primary auctions.
IrelandExclusive access to primary auctions and exclusive counterparty rights to repurchase and reverse repurchase operations of the National Treasury Management Agency, and bond-switching facilities.
ItalyExclusive access to noncompetitive taps within 10 percent of the total amount offered by the Treasury in the auction. Option to participate, in an exclusive way, in buy-back operations drawn on the “ad hoc” Government Sinking Fund.
NetherlandsExclusive access to primary auctions. The obligation of making available two-way quotes (market making) applies to primary dealers only. Primary dealers may use the title “primary dealer” for Dutch State Loans. It is increasingly considered a privilege by both primary dealers and nonprimary dealers.
NorwayBorrowing privileges with the central bank.
PortugalAccording to Regulation No. 1/2001, Art. 17, specialized primary dealers have a right to

- exclusive access to the noncompetitive phase of bond auctions;

- preference in syndicates and in other forms of placement of government debt;

- access to Institute for Public Debt Management facilities to support the market, namely the repo window;

- preference in carrying out transactions related to management of public debt; and

- privileged hearing in matters of common interest.
SingaporeExclusive access to primary auctions and counterparty rights for central bank’s open market operations, tax exemption on Singapore Government Securities (SGS) trading income. Only primary dealers can bid for SGS at auctions. The Monetary Authority of Singapore (MAS) holds regular meetings with the primary dealers to discuss market issues and conducts money market operations through these dealers only. Access to the MAS repurchase facility, which enables primary dealers with short positions to bid for specific SGS issues offered by the MAS in exchange for other SGS issues they have. This facilitates primary dealers’ market-making activities.
SpainAdvantage of an extra half hour for the submission of bids at bond auctions, exclusive access to the second round in auctions, exclusive access to stripping and reconstitution of bonds, privileged counterparty of the issuer in its overall debt-management activity (swaps, foreign currency issues, and similar securities), and access to regular meetings with the Treasury.
SwedenExclusive access to primary auctions and counterparty to central bank’s open market operations.
United KingdomExclusive access to primary auctions and participation in consultation meetings, secondary market dealing with the central bank.
United StatesBecause primary dealers are exclusive counterparties to central bank’s open market operations, dealers’ customers can participate through a primary dealer. Also, while dealers do not have borrowing privileges (for funds) with the central bank, they do have the ability to borrow securities from the central bank’s portfolio during its daily securities lending operation.
Developing Countries
ArmeniaExclusive counterparty for central bank’s open market operations. Primary dealers are allowed to bid for the entire issue, while other dealers can bid only for part of the issue. Only primary dealers are allowed to have noncompetitive bids.
GhanaExclusive access to primary auctions, and exclusive counterparty rights to central bank’s open market operations.
MoroccoAccess to the possibility to submit noncompetitive bids up to 20 percent of the amounts sold at weighted-average interest rate.
Emerging Markets
ArgentinaExclusive counterparty to the Secretariat of the Treasury’s open market operations, participation in a second round of primary auctions, and possibility to bid for noncompetitive tranches.
BrazilExclusive counterparty to the central bank’s open market operations.
Czech RepublicExclusive access to primary auctions.
HungaryExclusive access to primary auctions and information and consultation with the government debt management agency.
IndiaExclusive counterparty for the central bank’s open market operations, borrowing privileges with the central bank, and underwriting commissions.
KazakhstanExclusive access to primary auctions.
KoreaExclusive access to primary auctions and noncompetitive bidding.
MexicoBorrowing privileges with the central bank. Primary dealers also have access to a “green shoe” facility where as a group they can acquire up to an additional 20 percent of the fixed-rate securities offered in the primary auction at the average price that resulted in the auction. However, a prerequisite to access to the facility is to have won part of the primary auction.
ThailandExclusive counterparty to the central bank’s open market operations.
Source: IMF staff survey of national authorities (2001).
Source: IMF staff survey of national authorities (2001).

D. Foreign Institutions as Primary Dealers

The main arguments in favor of letting foreign institutions operate as primary dealers in a country are increased financial intermediation, greater availability of capital for credit, greater expertise, and increased competition. These are quite powerful arguments that must be weighed, mainly in developing countries, against regulatory capacity concerns and infant industry arguments. Specifically, if the regulatory framework and the authorities’ supervisory capacity are somewhat limited, extreme care should be taken when letting foreign institutions operate in the market for government securities. Also, if the authorities want to attract foreign banks, it is important to conform to international standards as much as possible. However, foreign banks might act more opportunistically than local banks, having less of a sense of loyalty to the local financial community. Branches of foreign banks, and especially those banks operating in countries with weak supervisory authorities and incomplete or inadequate legal and corporate governance framework, might—but by no means must—be allowed into the PD system after the following has taken place:

  • The local authorities have established contacts with their counterparts in the foreign country.
  • A careful review of the foreign country’s supervisory standards and compliance has been undertaken by the local authorities, if there is uncertainty about the quality of supervision in the foreign country.
  • The foreign legal and corporate governance framework has been assessed.
  • The foreign bank’s accounts have been certified by an international accounting firm, with no conflicts of interest in the foreign bank’s country of origin.

In view of these regulatory concerns, the authorities might want to require foreign banks to establish a fully incorporated local subsidiary company, with the parent company committed to support its activities.

E. Supervision

The supervision of primary dealers is an essential part in the development of a market for government securities, because primary dealers constitute a core group of financial institutions available for the liquidity needs of the government and, in some cases, for the conduct of monetary policy. From a broader perspective, the regulation and supervision of primary dealers are normally based on the 30 principles established by the International Organization of Securities Commissions (IOSCO), which are implemented under the relevant legal framework. The principles are based on three objectives of securities regulation:

  • the protection of investors;
  • ensuring that markets are fair, efficient, and transparent; and
  • the reduction of systemic risk.13

In establishing a system of primary dealers, the authorities must define what types of business, besides market making in government securities, primary dealers are allowed to undertake and what other supervisory authorities are involved besides the one with specific competencies and responsibilities for the primary dealers’ functions. From this first step, the authorities should be able to determine what other institutions and markets might have negative spillover effects from the failure of a primary dealer. The supervisory authority should therefore also prepare regulations to achieve the above objectives or invite the competent body to legislate on the issues as soon as possible. A proper legal framework is a necessary, although not a sufficient, condition for good supervision.14

Supervisory authority. It is important to establish at the onset of the system which institution has supervisory authority for the specific primary dealers’ functions. The main candidates are the central bank, the ministry of finance, or the regulatory authority in charge of capital markets (which could be part of the ministry of finance). The agency selected to supervise primary dealers may in turn rely on other supervisory agencies for some aspects of supervision. For example, if supervision of primary dealers is entrusted to the ministry of finance, it may rely in part on the central bank in its capacity as regulator of banks, particularly for prudential requirements. Similarly if a central bank is entrusted with supervision of primary dealers, it may rely on other regulators in its supervision of certain aspects of nonbank primary dealers.

If supervision is entrusted to the central bank and it conducts monetary policy using government securities, it is important that the primary dealers’ supervision department is clearly distinguished from the monetary policy department, that clear rules and procedures are established, and that lines of communication with management are kept separated between the two departments. Primary dealers should not feel that the information they are providing could be used to their disadvantage or, conversely, that the central bank is giving an unfair advantage to primary dealers over other financial institutions. However, if supervisory authority is vested in a regulatory body different from the central bank or the ministry of finance, that body should be well acquainted with the general aims and procedures of monetary policy and the objective of the government in establishing a network of primary dealers.

One particular issue deserves attention: if access to the auction is not restricted exclusively to primary dealers, special care should be taken that the other institutions having access to the primary market for government securities are not treated differently than primary dealers, and that different supervisory authorities coordinate their requests to and requirements of the different financial institutions.

Supervision. The supervisory body should set and enforce prudential standards, risk management and internal control standards, and standards governing business and market conduct. Prudential oversight should allow the authority to monitor the primary dealer’s capital position and ensure that dealer failures do not unduly disrupt the market. Moreover, clear rules should be established for position risk and credit risk assessment, based on international standards to ensure comparability. The supervisory regime also includes a detailed list of variables to be provided at established intervals (reporting frequency), as well as the data transmission and supporting infrastructure. If institutions other than banks are allowed to undertake business using government securities, and if these institutions are supervised by different bodies, the principles and the techniques for the measurement of capital and risk should be broadly the same to ensure a level playing field for different institutions and proper assessment of risk. The primary dealer should be subject to appropriate segregation rules so that customer assets are not used to support the primary dealer’s proprietary trading (or other) operations.

Table 7 provides an indicative list of the institutions responsible for supervision of primary dealers and enforcement of their obligations, as reported by the 39 countries surveyed for this study. Historical circumstance and stage of development are likely to have played a role regarding which institution is given primary responsibility for supervision of the primary dealers. In situations where most or all of the primary dealers are banks, there may be a tendency to assign responsibility to the central bank. Or, where the secondary market is relatively well developed, the regulatory agency responsible for regulating the securities market may also be assigned oversight of the PD system.

Table 7.Institutions Responsible for Supervision and Enforcement
Ministry of Finance/TreasuryCentral BankOther Institutions
ArgentinaArmeniaAustria: Federal Financing Agency
ArmeniaBrazilCanada: Investment Dealer Association
BelgiumCanadaGhana: Securities Regulatory Commission
CanadaCzech RepublicGreece: Public Debt Management Agency
Hungary: Government Debt Management
FranceGreeceIceland: National Debt Management Agency
GreeceIndiaIndia: Securities and Exchange Board of India
Ireland: National Treasury Management
ItalyMoroccoKazakhstan: National Security Commission
KazakhstanNorwayKorea: Stock Exchange
Portugal: Institute for Public Debt
MexicoSwedenSweden: Finance Supervisory Institution
MoroccoThailandUnited Kingdom: Financial Services Authority
NetherlandsUnited States
United Kingdom
United States
Source: IMF staff survey of national authorities (2001).
Source: IMF staff survey of national authorities (2001).

Code of Conduct. In setting up a PD system, another important document is a Code of Conduct that defines the principles and procedures for financial institutions operating in the secondary market for government securities.15 As such, all government securities dealers must comply with this Code. The document should not be specifically drafted for the PD system, but should be part of the framework regulating the market. It should describe the standards for trading in the wholesale domestic debt market by the dealers and their affiliates, and by the customers and counterparties with whom they deal. The purpose of this document is to promote public confidence in the integrity of the government securities market and to encourage the maintenance of active trading in such market. The Code should address the following issues:

  • Firm standards and procedures. Policies and procedures of financial institutions acting as dealers should be written and approved by the institutions’ Board of Directors and implemented by management. They should also indicate responsibility and control mechanisms, while ensuring the confidentiality of all dealings in the market.
  • Disclosure and reporting. This regards the “know-your-client” requirement and being able to give appropriate advice to clients. Also, conflict-of-interest policies and implementation procedures must be defined.
  • Market conduct. This issue requires members to behave according to ethical standards and public interest. It also calls for members to reject manipulative practices, bribes, and criminal and regulatory offenses. Dissemination of false information or inactively witnessing its spread is clearly forbidden. The issue of market conduct also requires members to familiarize themselves with market conventions and terminology, and ensure that proper understanding is reached when dealing with other institutions or customers.
  • Surveillance and enforcement. This issue specifically points to what compliance procedures and surveillance procedures apply. This latter should also include the reporting of important operations, large exposures, unusual differentials in the traded yield, and all that could upset the smooth functioning of the market. Lastly, sanctions should be defined (and applied) for all those who do not uphold these matters.

F. Other Operational Considerations and Legal Aspects

Agreements Between Authorities and Primary Dealers

From a legal viewpoint, setting up a system of primary dealers can take different forms: either informal (verbal); a written understanding in the form of, say, a Memorandum of Understanding (MOU); or a legal document. Countries have a variety of arrangements, ranging from very informal agreements (between the authorities and the primary dealers) to drafting legally binding documents. In general, in view of the nature of the arrangement (one that outlines mutually agreed-upon understandings and performance objectives) and as markets evolve rapidly and priorities would naturally change over time, it is advisable that such arrangements be embodied in an MOU, as opposed to a legal agreement. An MOU would be superior to an informal arrangement because it would promote greater transparency as to the arrangements and expected functioning, and set forth the criteria for entry and exit, while keeping the arrangement adjustable to change because MOUs can easily be revised.

It is always preferable, for both transparency and clarity of roles, to draft an MOU that clearly states the objectives and the strategy of the government in setting up the market (liquidity management, financial deepening, and monetary policy operations), the selection criteria to become a primary dealer, the obligations of the financial institution and of the authorities, the privileges of the primary dealer, and if necessary a summary set of rules applicable to auctions of government bonds. Moreover, the document should also clarify the supervisory framework, leaving aside the details that must be prepared separately and approved in the implementation stage of the system. Drafting an MOU would also help to assess consistency between the stated objectives and strategy, in addition to the overall design of the PD system, with specific obligations for the authorities. For example, it is important to avoid the problem of selecting a primary dealer strategy if the government is not committed to market-based mechanisms and transparent debt management practices. Also, the government may be committed to consult with the primary dealer group before making significant changes to the debt strategy. Elements of these commitments can be included in the MOU. Other areas that the MOU could usefully elaborate on include a trial period, the evaluation process, and monitoring.

The authorities might want to establish a trial period before a financial institution is awarded the status of primary dealer, and determine under what conditions the trial period could end, with final status being granted or not after the end of this period (that is, the document could specify that the trial period is a “phase-in” period where transitional rules apply, for example, regarding the amount of traded securities, participation at auctions, and so forth). The evaluation process for the primary dealer’s status should also be included, with a set of performance criteria and evaluation timing being specified.

These performance criteria could easily be the same as the ones necessary for continuous monitoring. This idea is important and complementary to the normal supervisory role; through monitoring, the authorities need to ensure that the requirements for the primary dealer status are actually met. The authorities might monitor on a daily basis and rank the primary dealers at review time. At this point, there are at least two options: the authorities might define a minimum threshold for each performance criterion, with primary dealers not meeting one or more of them having primary dealer status suspended and other institutions meeting these criteria being allowed in, without fixing a constant total number of primary dealers. Alternatively, the authority might want a fixed number of primary dealers, with the last in the ranking being eliminated while a new institution becomes a primary dealer. This system would allow a rotation in the role of counterparty to the public debt manager and stimulate competition. This procedure has recently been established in Mexico.

To strengthen contacts and communication between the debt manager and primary dealers, the authorities might require potential primary dealers to submit a “business plan” detailing how they are going to operate to promote and sell government securities. This could also be helpful in the selection process and in the monitoring of performance. In addition, it may be helpful to set up an advisory board made up of representatives from the primary dealer group, major investors, and the relevant public agencies. The board would meet on a regular basis, and also on an occasional basis as needed.

Organization of Responsibilities

Organization of responsibilities for government debt varies among countries and markets.16 If there is a unified debt manager, it is usually in charge of the arrangements in the primary and the secondary market (see, for example, Sweden). Under other arrangements, the ministry of finance is in charge of the primary market, while the central bank might assume the leading role in the secondary market. Whichever the arrangement, it should be transparent and responsibilities clearly defined, and coordination must be ensured among these institutions. As far as the PD system is concerned, it matters less who establishes it, but it should be clear which is the responsible institution. A continuous flow of communications among the ministry of finance, the central bank, and primary dealers is essential. To better perform these functions and also to provide increased coordination, an association of dealers might be put in place, which would then adopt a Code of Conduct (see above), or at least an association of primary dealers, as long as this is not detrimental to competition.


Transparency refers to the availability of full, accurate, and prompt information to the public. In the current context two aspects of transparency are especially relevant: (1) those concerning institutional objectives, responsibilities, arrangements and operating procedures; and (2) those about market prices, transactions volumes, and market position. With respect to the former, the Guidelines for Public Debt Management, recently established jointly by the IMF and the World Bank, call for transparency and accountability on the part of institutions involved with debt management policies and operations. In particular, Section 2.2 states, “Materially important aspects of debt management operations should be publicly disclosed.”17 This would include arrangements and agreements with primary dealers governing their primary and secondary market operations. The authorities should also develop a clear timetable for bond issues detailing amounts and maturities. This will force the authorities to take seriously the budget exercise and to forecast as accurately as possible their own financing needs.

In addition, the Code of Good Practices on Transparency in Monetary and Financial Policies, adopted by the IMF, calls for public disclosure of the central bank’s relationships and transactions with counterparties in its monetary operations and in the markets where it operates.18

With respect to market transparency, information about prices at which market participants are willing to transact is central to efficient price discovery. In addition, relevant information may include post-trade price and volume and identity of the market intermediary or client. Moreover, there is an inherent risk in setting up an inner ring of institutions with an oligopolistic access to auctions and information. The authorities should balance this aspect with the need to keep the market as transparent as possible for the ordinary investor.

Transparency in the context of markets is not without its costs. For example, if it becomes known that a primary dealer with a substantial position in a particular issue wants or needs to unwind it, this information can move the price against the dealer. Therefore, issues of transparency must be carefully weighed against all other considerations and then strike a sensible balance. In particular the following considerations usually apply. The primary dealer usually has reporting obligations—for example, to the stock exchange, the central bank, or the debt management agency. However, the primary dealer may be given exclusive access to the screen of the inter-dealer brokers and use these brokers to trade among themselves without disclosing their identity or their positions. Other special arrangements might include delays in disclosing larger transactions.


See International Monetary Fund and World Bank (2001b), p. 231.


Relations with the authorities are considered sometimes a selection criterion and other times an obligation, or both. Both stages require exchange of information; thus the considerations in this section will also apply to the reporting obligations in the following section and will not be repeated.


The time span can also be reduced so as to include only one auction at each time, a situation that would be equivalent to specifying the percentage of securities to be bought at each auction.


This criterion can be specified in the following way: if there are n PDs, a threshold of l/n percent would ensure a 100 percent coverage of the auction, while a threshold higher (lower) than l/n percent would ensure overbidding (underbidding).


The government should make every possible effort to build its own reliable liquidity forecasts when planning the issuance of securities and drafting an agreement with primary dealers. Moreover, if the central bank is operating with indirect instruments, uncertainty about government liquidity inflows and outflows will make it much more difficult for the central bank to reduce interest rate volatility.


When contacted, primary dealers should be willing to quote a firm price for a potential buyer or seller.


On this specific point, see also the discussion on relations with the authorities in the previous section.


We do not rule out the possibility that specific underwriting obligations might be in place in some countries, but this was not specified in the answers.


Termed “green shoe” in Mexico, “noncompetitive phase” in Portugal.


For a more extensive discussion of the legal and regulatory framework, see IMF and World Bank (2001b), Chapter 9.


See International Monetary Fund and World Bank (2001a).


See also International Monetary Fund and World Bank (2001a).


See International Monetary Fund and World Bank (2001a).


See International Monetary Fund (1999).

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