I. Introduction and Summary

This paper discusses the role of primary dealers in the management of public debt for countries that may be considering establishing such a system. One of the goals of the paper is to provide guidance on how to design a primary dealer system in an appropriate way to meet market development needs.² In addition, it tries to answer the question of under what conditions would a primary dealer system make a positive contribution to the functioning and development of the government securities market. However, it is difficult to give a precise analytical answer to this question for all countries, and thus the paper will draw on practical experiences for individual countries. To provide empirical support and detailed information for the project, a survey on primary dealers practices and views was sent to 47 countries, varying widely in terms of size and stage of economic development, and responses were received from 39 of these.

Many, but by no means all, industrial countries already have primary dealer systems, although many that do have established them only in the last few years. In addition, a number of emerging market and developing countries have either adopted, or are in the process of adopting, primary dealer systems, but many others have not done so.

Essentially, a primary dealer system is an agreement between two major stakeholders in the domestic government debt market—the debt manager and a group of dealers—to pursue a common strategy in support of the functioning and development of primary and secondary markets for government securities. Primary dealers (PD) are financial intermediaries that, generally in exchange for specific privileges, agree to perform specific obligations or functions in the operation of markets for government securities. Following from this definition, the roles include

1. acting as a channel between debt manager and investor in the primary market (for example, by participating in auctions);

2. performing as bookmakers and distributors by having dealers that canvass investors’ interest and distribute securities ahead of auctions through when-issued markets.

3. acting as providers of immediacy of liquidity to primary and secondary markets;

4. acting as providers of asset transformation and market-making services by being willing to hold inventories of government securities and allowing investors to swap between various outstanding issues of government securities on a continuous basis helps bring liquidity to the market;

5. promoting continuous markets and efficient price discovery by organizing dealers within an appropriate market structure that can encourage efficient price discovery;

6. acting as agents and relationship managers educating investors about the attractiveness of government securities as an investment; and

7. being advisors to the government by formulating and adopting appropriate strategies for the development of products and markets.

Selection criteria for primary dealers typically include financial strength as indicated by adequate capitalization; an active role in government securities markets and financial expertise, such as skilled management and staff, together with access to appropriate technology. Obligations generally include one or more of the following: (i) participating in the primary market in a substantial and consistent manner; (ii) serving as a market maker in the secondary market by providing two-way quotes, either indicative or firm, for specified groups of securities; and (iii) providing market-related information to the public debt manager, whose main objective is to ensure that the government’s financing needs and its obligations are met at the lowest possible cost, consistent with a prudent degree of risk.³ Privileges, or supporting arrangements, which vary widely among countries, generally involve the granting of some aspect of exclusivity—for example, the exclusive right to participate in the auction for treasury bills, and/or the right to serve as a counterparty to the central bank when it conducts open market operations, and/or access to a line of credit or permission to borrow particular issues from the central bank.

Among the respondent countries in the survey, there was broad agreement that primary dealers are recommendable—that is, they make a positive contribution to the development and liquidity of government securities markets of countries that did not have primary dealer systems (10 countries). Several respondents indicated that their markets were not large enough to support a sufficient number of primary dealers to ensure competitive behavior, while some of the more advanced countries indicated that their markets were functioning well without primary dealer systems (for example, Germany and New Zealand). Regarding the issue of at which stage of development one should introduce a primary dealer system, more than half indicated that it was either always desirable or desirable to do so in the early stages of development. With respect to later introduction, however, some of the detailed comments pointed toward conditions that should be present before development of a primary dealer system, such as the existence of a legal and supervisory system, and an adequate payment system.

The remainder of the paper is organized as follows. Section II discusses the objectives and rationale for a primary dealer system. Section III describes the benefits and costs of a primary dealer system, and Section IV the necessary conditions for a primary dealer system. Section V summarizes the results of the survey questionnaire on primary dealers that was sent to 47 countries. More details on the countries’ responses are provided in the two appendices.

II. Objectives and Rationale for a Primary Dealer System

The main purposes of a primary dealer system include strengthening the primary market by helping to build a stable, dependable source of demand for securities, by providing liquidity in the secondary market, devoting capital resources to underwriting (as a proprietary buyer) to absorb an occasional shortfall of liquidity, building distribution channels (to act as intermediaries) and providing market information, including prices, volumes, and spreads between bids and offers. These objectives in turn, serve the overall goals of: (i) lowering the cost and associated risk of servicing the public debt, (ii) developing financial markets, (iii) enabling the central bank to use indirect instruments of monetary policy, and (iv) encouraging saving by providing a relatively risk-free investment with attractive returns.

Development of financial markets involves a broader set of policies than just establishing a primary dealer system. In particular, some countries may have set up primary dealer systems without necessary supporting policies, including a commitment to a market-clearing outcome. Based on empirical observation, establishment of a primary dealer system can be an efficient way to develop and execute a coordinated approach to market development and thereby accelerate the development of market structure. Practical experience shows that primary dealer systems are in many cases a very helpful and efficient way to build up a market as well as maintain the functioning of the market in later stages. Other ways to set up markets, however, do exist,⁴ and in the choice of different setups country specificity and historical (path-dependence), considerations might well play a role, in addition to theoretical considerations.

In addition, setting up a system of primary dealers can be interpreted as a response to a market failure, if the government perceives that the existing market structure is not performing efficiently or if the market does not yet exist or is very thin. This happens typically in many developing countries, where the rationale for primary dealers may rest not only on efficiency arguments but also on developmental reasons, as argued below. Additionally, the creation of a primary dealer system can be seen as a commitment to sound debt management practices. By selecting a specialized set of institutions, the authorities might be signaling to the financial community and the public at large their commitment to a liberalized market and a sustainable public debt strategy. Therefore, defining such a group of qualified dealers might increase investors’ confidence in government securities as an investment.

In analyzing the issue of primary dealers, it is important to include considerations of securities market structure and development, and coordination of the various players involved. A decision whether to set up a primary dealer system, and the associated design, can be considered not only from a developmental point of view but also, in more advanced economies, from a market structure point of view. In this context, design of the mix of obligations and privileges must be an integral part of the strategy for developing and improving a government securities market, and the design itself can target market development (create a market, accommodate public sector borrowing requirements) and/or market structure (competition, efficiency, financial instruments).

From a developmental point of view, in the early stages of development the authorities might view the existence of a group of specialized institutions as instrumental in supporting their efforts to develop a market for government securities. These institutions would concentrate limited expertise and scarce resources in a limited number of players, thereby facilitating coordination among players and supporting a smooth market process. For instance, in the absence of liquid funding markets, a broad and well-informed investor base, available and well-developed trading platforms, and a supporting infrastructure, a primary dealer system can be a very useful platform upon which to develop the government securities market. In this context, it is clear the developmental role that a coordinated set of players can have in supporting government-borrowing strategy, while at the same time creating some of the conditions for the use of indirect instruments of monetary policy.

The design of the primary dealer system as a developmental objective should aim at a mix of obligations, privileges, and supporting arrangements that help the authorities to achieve their objectives. Equally important, other supporting markets or infrastructures are likely to be missing in this context, so there must be a commitment from the authorities to implement policies to put in place necessary infrastructure (e.g., book-entry system, DVP, and bidding technology) and to develop other markets (interbank market and local capital market, for instance). Given this background, the performance of primary dealers can be expected to be less than optimal, but mechanisms should be put in place to limit possible non-competitive behavior and moral hazard.

In more advanced economies, where developmental issues become less pressing, a market structure approach is also useful. When a country has already developed market intermediaries and infrastructures, the reasons for having a primary dealer system are different from the ones highlighted above. Arguments for specialization and economies of scale tend to prevail, and country experience in advanced economies (France, Italy) indicates that a primary dealer system accomplishes several objectives: (i) decreases market and refinancing risk, (ii) improves knowledge of the market, (iii) strengthens product and process innovations, (iv) provides better access to end investors, (v) improves promotion of debt, and (vi) provides skillful advisory support in building and following the debt management policy. One could also argue that some potential threats to an efficient market functioning must be taken into account—for instance, by selecting a preferential group of intermediaries, the authorities might reduce competitive neutrality and limit contestability. In addition, when the authorities have introduced on-line trading systems and financial markets and intermediaries are extremely sophisticated, as in the United States, which has had a system of primary dealers for a long time, the case for a primary dealer system becomes less clear. When there are substantial fiscal deficits and financing needs, however, primary dealers may continue to play a positive role in the primary market even in developed markets.

The practice of selecting a specialized group of intermediaries for government securities can be seen as similar to the practice of private commercial borrowers that implement their financing strategy via placements through a specific group of investment banks for the same reasons highlighted above (advisory, access investors, lower market and financing risk and so forth). However, there are additional risks in taking this approach by a government with a specific group of primary dealers. One risk is increased moral hazard, or the possibility that designated primary dealers will engage in more risky behavior because they have been selected by the authorities. Also, customers may assume in error that primary dealers are guaranteed by the government or central bank. In addition, compared with the private market solution, selection by the authorities may risk reduced contestability and possible anti-competitive behavior.

Therefore, it is essential that in deciding for the adoption of a primary dealer system, the authorities design mechanisms to reduce these risks, while preserving as much of the benefits as possible. Contestability can be supported by rotating primary dealers based on performance (Mexico), while the risk of anti-competitive behavior must be addressed by strengthening supervision. The argument for moral hazard/implicit guarantees must also be addressed in the context of liquidity/crisis management policies by designing an appropriate structure of incentives and controls.

In deciding for the adoption of a primary dealer system, the authorities should simultaneously address these issues to achieve their debt management objectives while maximizing market efficiency. Countries that have fairly advanced markets and intermediaries, but that for some reason would not be able to address the negative effects induced by the introduction of a primary dealer system, should strengthen their capacity of intervention in these areas before putting the system in place, or phase in supervisory and regulatory reforms at the same time. While in developing economies the developmental aspects can outweigh downsides related to market structure, in more advanced economies the authorities should clearly evaluate whether the market would not be able to perform the same functions without introducing a selected subgroup of specialized intermediaries.

Another aspect of a primary dealers activity in the secondary market is to serve as an intermediary between the debt manager, often the central bank, and retail investors. In this regard, primary dealers are often expected to serve as partners with the debt manager and central bank in developing the institutional and retail markets. This function may include educating the public about investing in government securities.

In recent years, a number of debt managers in developed economies have been moving into direct retail sales of securities over the internet. More generally, modernization of markets and automation are making some of the functions traditionally performed by primary dealers less important or redundant. For example, automation gives a means to handle large numbers of participants in auctions that was not previously possible. Electronic markets offer information on market conditions and prices that might formerly have been possible to have only directly from dealers. Whether this recent trend in developed economies also applies for the needs of developing countries depends on country-specific situations, given the technological possibilities and constraints that different countries face.

III. Benefits and Costs of Primary Dealer System

By selecting certain firms as primary dealers and not others, authorities concentrate market activity in a smaller number of firms, which has both positive and negative implications. On the positive side, especially in the early phases of market development, there can be important efficiencies associated with larger volumes of financial transactions, including automation and more advanced technology, and the use of specialized, highly skilled personnel. Acquiring these resources has substantial fixed costs, and spreading these costs over a larger volume makes them more economical. Competition and efficiency can also increase if foreign firms are allowed to become primary dealers, if as seems likely those firms are advanced and have an international clientele. In addition, there are advantages to the debt manager in limiting the number of institutions with which it has to deal in conducting auctions of government securities and (if it is the central bank) in its open market operations. A general benefit of a primary dealer system is that it reduces both risks and the risk management burden. The quality criteria reduce credit, execution, settlement and operational risks; and the limited number of dealers makes the administrative and credit monitoring burden more manageable.

The most significant possible problem of setting up a primary dealer system is the risk of promoting a less than efficient market structure. A primary dealer system is a dealer market structure; developing one involves choosing (by the issuer) this particular market structure for the trading and issuance of debt. If alternative market structures are more efficient or appropriate, then a primary dealer system is best avoided and a different and more appropriate country-specific strategy developed.⁵

A second drawback of a primary dealer system is that it can potentially limit competition and contribute to oligopolistic behavior. Since selection is fundamental to a primary dealer system, it can in some respects run counter to the principle of establishing a level playing field. To a considerable extent, however, these potential “negatives” can be avoided by careful design of the system, for example, by not unduly limiting the number of market participants.

In addition, by selecting a group of financial firms to serve as primary dealers, there is a risk that the public may view them as possessing an implicit guarantee by the government. There may also be moral hazard in that guarantee, in that once selected as a primary dealer, the primary dealer may engage in more risky behavior, believing that the government would not stand by and let it fail. In this regard, the primary dealer might be induced to take on more risks than it otherwise would. Authorities should try to reduce this moral hazard by supervision and by allowing contestability. For example, periodically, authorities may reassess and reselect the group of primary dealers.

Since establishing a system of primary dealers has its pros and cons, an important question concerns whether, or under what conditions it is helpful to have such a system. In general, the answer depends on the authorities’ overall strategy for developing the government securities market and the appropriate microstructure for the market. In particular, if authorities envision a secondary market structure in which there are competing dealers and market makers, then a primary dealer system may be an appropriate choice. However, authorities may opt for an auction system with direct buy and sell orders to a single location or electronic matching system, in which case a primary dealer system might not be appropriate. Or, alternatively, the secondary market may be too small to support an effective number of primary dealers, in which case the authorities may decide as a transitional measure to open a secondary window at the central bank.

The justification for establishing a system of primary dealers is that the system satisfies public goals that might otherwise not be met. One of the main goals in this regard is to maintain or enhance the liquidity of secondary markets. A liquid market may involve external benefits that accrue to other parties that are not directly involved in the government securities market.

It may be useful to consider whether the tradeoff between the advantages and the disadvantages of a primary dealer system changes during the course of economic development. In the early stages, for instance, not all of the key conditions may be present for an effective primary dealer system. In particular, there may not be enough dealers who are active in the government securities market. Moreover, in those early stages, the commercial banks, which are some of the most likely candidates for primary dealership, may have a vested interest in not developing the government securities market, since they have competing products and may profit from the scarce opportunities of their depositors. In addition, the size of the financial system, and of the government securities market in particular, may play an important role, with smaller countries finding it more difficult to justify a primary dealer system. In this context, the potential for specialization on the part of dealers in government securities is limited by the small size of the financial market. At the same time, the potential contributions of a primary dealer system—developing the primary and secondary markets and developing the retail base for government securities—are most relevant for developing and emerging-market countries.

In the latter stages of financial development, especially in large diversified financial systems (Germany or Switzerland), the need for, or potential contributions from a primary dealer system may be less important. In many developed countries, there may be a relatively large number of active participants in the primary market; and there may be an active and highly competitive secondary market, while retail investors have a number of attractive alternatives. Thus, some industrial countries, such as Australia, Germany, Japan, New Zealand, and Switzerland, do not have primary dealer systems, while the United States with the largest and most diversified financial system in the world does have such a system. The United States, however, has reduced the privileges of primary dealers over time, and opened the system to more competition. Now, aside from being recognized as a primary dealer, the main privilege is to be one of the counterparties to the Federal Reserve when it conducts its open market operations. More generally, the role and specific features of a primary dealer system may change during the course of economic development.

IV. Necessary Conditions for a Primary Dealer System

Important prerequisites for establishing a primary dealer system include at least eight listed below:

A government must have a strategy for issuing government securities: a government must accurately plan its debt issuance strategy so as to provide a medium-term horizon for the investment strategy of primary and secondary market agents.

Interest rates should be liberalized: it is essential, that interest rates on government securities reflect actual demand and supply, in both the primary and secondary markets, to guarantee efficient price discovery.

An adequate number of end investors is necessary: this means that the government should try to estimate potential demand among individuals and the financial sector and be able to fine-tune its own supply, arising from its financing needs, to be able to meet potential demand. Preliminary discussions with banks will help the government gauge this potential absorption capacity.

A minimum set of attractively designed securities should be available: In deciding its debt strategy, the government should plan for a certain number of different types of securities, taking into account different maturities and trying to establish benchmarks. In addition, other instruments could include index-linked securities, inflation-linked securities, to mention just some simple examples that can help investors diversify their portfolios of instruments and provide instruments for risk management.

The government must be committed to secondary market development: this condition is important because it guarantees the primary dealers and other market participants that they will not compete directly with the government in the placement of securities in the retail market. The authorities should refrain from intervening directly in the market, for instance, limiting or avoiding, direct sale of securities.

The government must also be committed to market-determined outcomes: the authorities should make efforts to stimulate a setup of the primary and secondary market to allow competitive forces to play a dominant role. In this context, primary dealers should not be seen as a captive group that can be burdened with government securities, but rather as the initiators of a market or a group providing additional liquidity and transparency to the market for the purpose of better price discovery and resource allocation.

Arrangements between primary dealers and the debt managers in support of the auction system should be carefully arrived at: this is an important prerequisite, since the auction is the central mechanism for securities allocation in the primary market. The auction design must allow an efficient price discovery. Problems in auction design are bound to have a strong negative effect on subsequent segments of the market, since inefficient price discovery or inefficient allocation will impact the secondary market both at wholesale and retail level.

Sufficient debt and a potential volume of secondary market trade should be available to support a profitable group of competing dealers without subsidies for the operations: with respect to the size of the market, it is important to have an adequate number of active participants in the market, and enough volume in government securities issued to justify a primary dealer system. In addition to authorities’ commitment to market-determined prices and attainment of a minimum size of the market for government securities, there are other highly desirable conditions for establishing a primary dealer system, including a legal framework for government securities, a regulatory/supervisory system for government securities dealers, and an adequate payment and settlement system. However, the primary dealers can be used as a platform and an integral part of the building of such systems. In many developing and emerging market countries for instance, primary dealers have been used as custody agents as part of the book entry system. They have been given accounts with central banks to clear and settle on a Delivery Versus Payment (DVP) basis. In addition, in some countries, the setting up of primary dealers has been the cornerstone of developing efficient primary markets.

In the early stages of development and for many small developing countries, there may not be enough participants in the government securities auctions to reduce the number further by establishing a primary dealer system. Having an adequate number of participants in the auction may be a particular problem if the authorities are trying to limit participants to commercial banks for clearing and settlement purposes. If the main objective is to be as inclusive as possible for bidding at the auctions, then limiting the numbers further in order to start a primary dealer system may be inappropriate.

Thus, one of the respondents to the questionnaire from countries without primary dealer systems said the reason the country had not set up a primary dealer system was the small size of the market (Latvia), and another (Chile) that there were too few participants for establishing a primary dealer system.

What is the minimum number of primary dealers to ensure an acceptable degree of competition? While there are no absolutes on this issue, five to seven seemed to be among the minimum numbers of primary dealers cited by respondents in the MAE survey (e.g., Mexico, Norway, Armenia, Morocco, and Sweden), although Iceland, which recently established a primary dealer system, has only five primary dealers. Chile, in particular, indicated that four to seven primary dealers were not enough—a key reason why Chile did not adopt a primary dealer system.

Based on the survey, the typical number of primary dealers for a country with a successful primary dealer system seemed to be approximately 15, and 20 to 26 primary dealers was toward the high end of the range.⁶ Several respondents indicated that the number of primary dealers had been increased as the volume of dealing had grown over time (e.g., Brazil and India), while several others indicated that the number had fallen as the volume of securities issued had declined (e.g., Canada and Sweden). There were also other reasons for a trend toward declining numbers of primary dealers, including in particular, consolidation of the financial services industry. In the case of the United States, the number of primary dealers peaked in 1988 at 46, and has since declined to 25, owing largely to consolidation within the industry.

V. Survey Results

In April 2001, a survey questionnaire on primary dealers was sent to 47 countries. Of the 39 respondents, yielding a turnout rate of about 83 percent, 20 are advanced economies, 13 are emerging markets, and six are developing countries.

Among the respondents, 29 have primary dealers and 10 do not. Fourteen introduced primary dealers after 1995 (Figure 1), indicating a relatively recent trend in establishing primary dealers, but also indicating a relative degree of satisfaction with primary dealerships. Among the countries included in the survey that have not established a primary dealer system, three are advanced economies (Australia, Germany, and New Zealand), four are emerging markets (Chile, Indonesia, Latvia, Poland), and three are developing countries (Kenya, Mauritius, and Saudi Arabia).⁷

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Year of Establishment of a Primary Dealer

Citation: IMF Working Papers 2003, 045; 10.5089/9781451846492.001.A001

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Countries with a system of primary dealership have a wide range of Public Debt/GDP ratios, but a certain concentration of countries can be noted around a 35 to 50 percent ratio. Figure 2 relates the presence of PD with the size of debt relative to GDP in the initial year of primary dealership.

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Debt-to-GDP Ratio as of the Introduction of Primary Dealer (PD) System, or as of 1999 for Countries without Primary Dealer Systems

Citation: IMF Working Papers 2003, 045; 10.5089/9781451846492.001.A001

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Fourteen (or 36 percent) of the respondents perceive a link between the size of public debt and the desirability of having a primary dealer system. Specifically, among advanced economies nine of the respondents think that there is a relationship between the size of public debt and the desirability of primary dealers, namely Belgium, Canada, Finland, Greece, Italy, Norway, Singapore, and Spain, with Australia agreeing only for small market size. Two share this view among emerging markets (India and Poland) and three among developing economies (Kenya, Mauritius, and Saudi Arabia).

In reporting the most important advantages mentioned in the survey responses, we can distinguish between the primary and secondary market. In the primary market, several countries (Armenia, Australia, Canada, Ghana, India, Italy, Kenya, Spain, and Thailand) mentioned that a primary dealer system improves the coverage/underwriting of the auction and some pointed out the support that the debt manager can gather with professional market information and market-tailored securities (Hungary, Italy, Morocco, Netherlands, and Poland). In regard to the secondary market, most countries mentioned improved market liquidity; and Canada, Iceland, India, Ireland, Korea, Norway, Singapore, and Thailand mentioned the creation of market making activities. At a more general level an important contribution is the development and well functioning of the secondary market that primary dealers can help ensure, a point made by Australia, Canada, Chile, Hungary, Indonesia, Mauritius, Saudi Arabia, Singapore, and Spain.

With respect to monetary operations, the United States, Brazil, India, Thailand, Kenya mentioned that the presence of a stable set of counterparties of the central bank facilitates the implementation of monetary policy (for those countries where primary dealers in government securities coincide with central bank counterparties for monetary operations).

Table 1.

Survey of Advantages of a Primary Dealer System

Source: Survey of national authorities.

Table 1.

Survey of Advantages of a Primary Dealer System

Developed Countries
Australia	Can boost liquidity and development of the market. Primary issuance can be underwritten (to some extent).
Austria	Providing permanent services.
Belgium	Reach additional investors; focus on placing and trading of debt, compensated by special rights.
Canada	Ensures a minimum level and quality of coverage at auction regardless of market conditions. Maximum auction limit and net position reporting act to prevent most squeezes. Market-making responsibilities enhance the liquidity and well functioning of the Government of Canada securities market.
Finland	Committed sales force, research, distribution of government debt.
France	Decreasing market and refinancing risk; knowledge of the market; capacity of innovation; access to a wider sales force and better promotion of the debt.
Germany	No comment.
Greece	No comment.
Iceland	Four market makers are now, together with PDs, obligated to take part in auctions and to give two-way quotes within a determined range. This leads to a better market price, increased price formation in the secondary market and enhances the treasury’s access to the market. Turnover in the secondary market has increased.
Ireland	PDs reduce the cost of borrowing by providing a continuous two-way liquid market in government bonds; create certainty in secondary market; eliminate illiquidity premium cost; allow debt to be restructured; act as sounding board for changing debt strategy; facilitate closer organized contact with the investors.
Italy	Full and constant coverage of auctions. Better knowledge of market conditions in order to improve the issuance strategy in terms of cost of funding reduction and financial risk control. Higher liquidity of bonds on the secondary market. Availability of a skillful advisory support in building and following the debt management policy. Possibility of being put in contact with a much higher number of investors in order to capture at any moment convenient issuance opportunities. Availability of a competent support in designing market-tailored securities.
Netherlands	Establishes a core group of banks that compete to buy the issuer’s bonds, provides information on market movements and trends.
New Zealand	No comment.
Norway	With quotes two-ways the market always has price information, and better liquidity.
Portugal	The issuer gains: access to a permanent distribution channel of debt, both domestically and internationally; a permanent secondary market; more visibility with final investors (especially foreign ones).
Singapore	PDs play a critical role in facilitating the growth and development of a young bond market with a small and limited investor base, for the following reasons: - having a group of PDs committed to making two-way prices helps provide a minimum level of liquidity that is a precondition for attracting investors into the market. - foreign PDs that are key participants in developed bond markets bring with them knowledge and expertise, which can help speed the growth and development of the bond market. - foreign PDs with a global client base would be committed to attracting their investor clients to the developing bond market.
Spain	They allow for a broad and efficient secondary market for government securities. With respect to the primary market, they ease the allocation of new issues.
Sweden	In order to have some guarantee of providing good liquidity, PDs are the best alternative. For the moment, the Swedish National Debt Office is paying fees on bonds, but not on T-bills. Some countries have systems which include fees to the PDs.
United Kingdom	More liquid market; easier to be transparent; easier auctions, and settlement, reduced credit risk monitoring, distribution of securities.
United States	Having a PD system facilitates the implementation of monetary policy by having a stable set of counterparties that are obliged to participate in open market operations and other central bank business.
Emerging Markets
Argentina	PDs’ commitment ensures the allocation of an important portion of public debt. It also specializes financial institutions dedicated to local market.
Brazil	Primary Dealers help the central bank in its function of keeping market informed about the implementation of the monetary policy. They assist in the execution of open market operations (outright operations and repurchase agreements) aimed to adjust the day-to-day needs to add or drain reserves.
Chile	Better information and development of secondary markets; more liquid and deeper market for our debt instruments.
Czech Republic	Stable structure of counterparts; easier administration and communication with market; transparent and reliable channel for cash and securities distribution; higher probability to sell securities.
Hungary	Secured base for sale of government securities; supporting the secondary market of government securities; direct connection to and information exchange with market actors.
India	Underwriting and market-making abilities exclusively in government securities market will be developed. Improved liquidity for government securities. OMO could be effective and operationally simpler once PDs become exclusive counterparties for central bank’s open market operations.
Indonesia	PDs can develop secondary market for government bonds and create market liquidity.
Kazakhstan	It is easy to control and systemize primary market.
Korea	Reduce the cost of government bond issue since a government does not have to pay underwriting fees; strengthen the demand base of the government bond; strengthen the stability of bond market by establishing leading market makers.
Latvia	Generates increase in liquidity and reduction in margins.
Mexico	The increase in liquidity that they offer to the market.
Poland	There are several advantages, including: - reliability of financing State Budget needs, even in single currency environment, - liquidity & transparency of the government securities market, - cost effective financing, and - the exchange of information about market and issuer policy.
Thailand	Effective channel for conducting open market operations; have active market makers to enhance the liquidity in the secondary market; ensure successful outcome in the primary market auction.
Developing Countries
Armenia	Better participation in the auctions; higher liquidity of government securities market.
Ghana	Maximum participation in the auction is ensured. The market is relatively more competitive. It is allowing for a relatively vibrant secondary market.
Kenya	Provides a smooth transition from a direct to a fully market-based system; produces increased efficiency in the auction process and open market operations; provides secure maximum participation in auction of government securities; improves functioning of primary markets and terms of government borrowing; enhances liquidity in the secondary market; brings about greater competition and leads to cheaper dealing costs in the secondary market.
Mauritius	To activate secondary market for treasury bills. To enable buyers and sellers to transact efficiently at prices reflecting fair values.
Morocco	Organization of the bond market, promotion of treasury bills, exchange of information on available bids as well as the price levels at which the investors are ready to subscribe.
Saudi Arabia	To enhance market efficiency and liquidity along with creating active secondary market.

Source: Survey of national authorities.

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Table 1.

Survey of Advantages of a Primary Dealer System

Developed Countries
Australia	Can boost liquidity and development of the market. Primary issuance can be underwritten (to some extent).
Austria	Providing permanent services.
Belgium	Reach additional investors; focus on placing and trading of debt, compensated by special rights.
Canada	Ensures a minimum level and quality of coverage at auction regardless of market conditions. Maximum auction limit and net position reporting act to prevent most squeezes. Market-making responsibilities enhance the liquidity and well functioning of the Government of Canada securities market.
Finland	Committed sales force, research, distribution of government debt.
France	Decreasing market and refinancing risk; knowledge of the market; capacity of innovation; access to a wider sales force and better promotion of the debt.
Germany	No comment.
Greece	No comment.
Iceland	Four market makers are now, together with PDs, obligated to take part in auctions and to give two-way quotes within a determined range. This leads to a better market price, increased price formation in the secondary market and enhances the treasury’s access to the market. Turnover in the secondary market has increased.
Ireland	PDs reduce the cost of borrowing by providing a continuous two-way liquid market in government bonds; create certainty in secondary market; eliminate illiquidity premium cost; allow debt to be restructured; act as sounding board for changing debt strategy; facilitate closer organized contact with the investors.
Italy	Full and constant coverage of auctions. Better knowledge of market conditions in order to improve the issuance strategy in terms of cost of funding reduction and financial risk control. Higher liquidity of bonds on the secondary market. Availability of a skillful advisory support in building and following the debt management policy. Possibility of being put in contact with a much higher number of investors in order to capture at any moment convenient issuance opportunities. Availability of a competent support in designing market-tailored securities.
Netherlands	Establishes a core group of banks that compete to buy the issuer’s bonds, provides information on market movements and trends.
New Zealand	No comment.
Norway	With quotes two-ways the market always has price information, and better liquidity.
Portugal	The issuer gains: access to a permanent distribution channel of debt, both domestically and internationally; a permanent secondary market; more visibility with final investors (especially foreign ones).
Singapore	PDs play a critical role in facilitating the growth and development of a young bond market with a small and limited investor base, for the following reasons: - having a group of PDs committed to making two-way prices helps provide a minimum level of liquidity that is a precondition for attracting investors into the market. - foreign PDs that are key participants in developed bond markets bring with them knowledge and expertise, which can help speed the growth and development of the bond market. - foreign PDs with a global client base would be committed to attracting their investor clients to the developing bond market.
Spain	They allow for a broad and efficient secondary market for government securities. With respect to the primary market, they ease the allocation of new issues.
Sweden	In order to have some guarantee of providing good liquidity, PDs are the best alternative. For the moment, the Swedish National Debt Office is paying fees on bonds, but not on T-bills. Some countries have systems which include fees to the PDs.
United Kingdom	More liquid market; easier to be transparent; easier auctions, and settlement, reduced credit risk monitoring, distribution of securities.
United States	Having a PD system facilitates the implementation of monetary policy by having a stable set of counterparties that are obliged to participate in open market operations and other central bank business.
Emerging Markets
Argentina	PDs’ commitment ensures the allocation of an important portion of public debt. It also specializes financial institutions dedicated to local market.
Brazil	Primary Dealers help the central bank in its function of keeping market informed about the implementation of the monetary policy. They assist in the execution of open market operations (outright operations and repurchase agreements) aimed to adjust the day-to-day needs to add or drain reserves.
Chile	Better information and development of secondary markets; more liquid and deeper market for our debt instruments.
Czech Republic	Stable structure of counterparts; easier administration and communication with market; transparent and reliable channel for cash and securities distribution; higher probability to sell securities.
Hungary	Secured base for sale of government securities; supporting the secondary market of government securities; direct connection to and information exchange with market actors.
India	Underwriting and market-making abilities exclusively in government securities market will be developed. Improved liquidity for government securities. OMO could be effective and operationally simpler once PDs become exclusive counterparties for central bank’s open market operations.
Indonesia	PDs can develop secondary market for government bonds and create market liquidity.
Kazakhstan	It is easy to control and systemize primary market.
Korea	Reduce the cost of government bond issue since a government does not have to pay underwriting fees; strengthen the demand base of the government bond; strengthen the stability of bond market by establishing leading market makers.
Latvia	Generates increase in liquidity and reduction in margins.
Mexico	The increase in liquidity that they offer to the market.
Poland	There are several advantages, including: - reliability of financing State Budget needs, even in single currency environment, - liquidity & transparency of the government securities market, - cost effective financing, and - the exchange of information about market and issuer policy.
Thailand	Effective channel for conducting open market operations; have active market makers to enhance the liquidity in the secondary market; ensure successful outcome in the primary market auction.
Developing Countries
Armenia	Better participation in the auctions; higher liquidity of government securities market.
Ghana	Maximum participation in the auction is ensured. The market is relatively more competitive. It is allowing for a relatively vibrant secondary market.
Kenya	Provides a smooth transition from a direct to a fully market-based system; produces increased efficiency in the auction process and open market operations; provides secure maximum participation in auction of government securities; improves functioning of primary markets and terms of government borrowing; enhances liquidity in the secondary market; brings about greater competition and leads to cheaper dealing costs in the secondary market.
Mauritius	To activate secondary market for treasury bills. To enable buyers and sellers to transact efficiently at prices reflecting fair values.
Morocco	Organization of the bond market, promotion of treasury bills, exchange of information on available bids as well as the price levels at which the investors are ready to subscribe.
Saudi Arabia	To enhance market efficiency and liquidity along with creating active secondary market.

Source: Survey of national authorities.

The strongest disadvantage that most countries noticed of having a primary dealer system is the potential distortion of competition and the creation of uneven playing fields, giving an unfair advantage to some market participants (lack of competitive neutrality, constrained contestability and likelihood of conservatism). Canada therefore stressed the need for regular monitoring and Saudi Arabia for regulatory guidelines, while Mexico underlines the importance of a careful balance between obligations and privileges. Brazil mentions potential informational asymmetries, while Italy noticed the risk for the debt manager to be influenced by views that tend to represent the interest of the primary dealers. If competitive behavior is not assured, then Indonesia points out that price formation might not lead to a competitive market price. The USA noted that the official designation of “primary dealers” could be (erroneously) viewed as granting a special status or guaranteeing creditworthiness.

On the other side, France, Iceland, Kazakhstan, Korea, Netherlands, and Spain, indicate no disadvantages with a primary dealer system.

Table 2.

Survey of Disadvantages of a Primary Dealer System

Source: Survey of national authorities.

Table 2.

Survey of Disadvantages of a Primary Dealer System

Developed Countries
Australia	May discourage participation by some potential intermediaries not designated as PDs. Investors cannot directly purchase securities at time of primary issue.
Austria	No comment.
Belgium	A concentration of PDs is developing in the banking community all over the world, with the same PDs evident globally. The result is a certain degree of oligopoly power.
Canada	Requires regular measuring and monitoring to ensure compliance with 1998 rules.
Finland	No comment.
France	None.
Germany	No comment.
Greece	No comment.
Iceland	None so far.
Ireland	Recognition of commercial pressures that the PDs face.
Italy	Risk for the debt management policy of being sometimes influenced by views that are more biased toward PDs’ own interests than on those of the sovereign issuer.
Netherlands	So far, none.
New Zealand	No comment
Norway	The central bank must give some privileges to the PDs.
Portugal	No comment.
Singapore	In a system where PDs receive privileges in return for fulfilling their obligations, this could create an uneven level playing field vis-à-vis non-PD market participants.
Spain	We cannot see any disadvantages of having PDs.
Sweden	No comment.
United Kingdom	Administrative burden, acquisitions of cartels, requires supervision.
United States	The designation of “Primary Dealer” is often viewed as giving the institutions a special status or guaranteeing their creditworthiness.
Emerging Markets
Argentina	Differences between participants (PDs) might limit competition.
Brazil	The possibility of establishing unwilling links between the trading desk and a Primary Dealer due to their daily contacts. Creation of some market inefficiencies and information asymmetry.
Chile	To leave out pension funds (AFP) and insurance company from the debt auctions. To depend on a small amount of institutions that can fulfill the demands of primary dealer.
Czech Republic	Under certain conditions other investors might be penalized for not being PDs by possible higher prices the may pay using the PDs as intermediary. But it depends on the level of development of the market and the level of competition.
Hungary	Free competition is limited in a way.
	Part of the debt financing depends on the performance of a limited number of market actors.
India	Highly depend on short-term funding, making the money market volatile.
Indonesia	This might be minor disadvantage: by having primary dealers, the price might not reflect the market price, so not many participants can do securities transactions. The price seems determined only by primary dealers.
Kazakhstan	There are no serious disadvantages of having PDs.
Korea	Nothing particular.
Latvia	Primary dealers should hold broad range of government securities constantly and are forced to participate in every auction of primary market.
Mexico	If obligations and benefits are not set right, the ranking index could give a competitive advantage to some intermediaries over others.
Poland	The danger of collusion when there are mainly: - fusion of banks in globalization environment - lack of competitiveness.
Thailand	If the primary dealers are not efficient, the liquidity injection and absorption of the central bank will not be successful.
Developing Countries
Armenia	No comment.
Ghana	PDs can consolidate and influence the market. The banks, as PDs, have products which are in competition with government securities and their commitment cannot be guaranteed.
Kenya	Collusion may occur where only few firms are accepted as PDs leading to lower auction prices and high intermediation costs passed onto the end investors.
Mauritius	PDs may buy securities with attractive yields and hold them instead of trading them.
Morocco	No comment.
Saudi Arabia	Possible manipulation of prices, if the size of the capital market is small and/or if regulatory guidelines are not sufficient to ensure a fair play.

Source: Survey of national authorities.

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Table 2.

Survey of Disadvantages of a Primary Dealer System

Developed Countries
Australia	May discourage participation by some potential intermediaries not designated as PDs. Investors cannot directly purchase securities at time of primary issue.
Austria	No comment.
Belgium	A concentration of PDs is developing in the banking community all over the world, with the same PDs evident globally. The result is a certain degree of oligopoly power.
Canada	Requires regular measuring and monitoring to ensure compliance with 1998 rules.
Finland	No comment.
France	None.
Germany	No comment.
Greece	No comment.
Iceland	None so far.
Ireland	Recognition of commercial pressures that the PDs face.
Italy	Risk for the debt management policy of being sometimes influenced by views that are more biased toward PDs’ own interests than on those of the sovereign issuer.
Netherlands	So far, none.
New Zealand	No comment
Norway	The central bank must give some privileges to the PDs.
Portugal	No comment.
Singapore	In a system where PDs receive privileges in return for fulfilling their obligations, this could create an uneven level playing field vis-à-vis non-PD market participants.
Spain	We cannot see any disadvantages of having PDs.
Sweden	No comment.
United Kingdom	Administrative burden, acquisitions of cartels, requires supervision.
United States	The designation of “Primary Dealer” is often viewed as giving the institutions a special status or guaranteeing their creditworthiness.
Emerging Markets
Argentina	Differences between participants (PDs) might limit competition.
Brazil	The possibility of establishing unwilling links between the trading desk and a Primary Dealer due to their daily contacts. Creation of some market inefficiencies and information asymmetry.
Chile	To leave out pension funds (AFP) and insurance company from the debt auctions. To depend on a small amount of institutions that can fulfill the demands of primary dealer.
Czech Republic	Under certain conditions other investors might be penalized for not being PDs by possible higher prices the may pay using the PDs as intermediary. But it depends on the level of development of the market and the level of competition.
Hungary	Free competition is limited in a way.
	Part of the debt financing depends on the performance of a limited number of market actors.
India	Highly depend on short-term funding, making the money market volatile.
Indonesia	This might be minor disadvantage: by having primary dealers, the price might not reflect the market price, so not many participants can do securities transactions. The price seems determined only by primary dealers.
Kazakhstan	There are no serious disadvantages of having PDs.
Korea	Nothing particular.
Latvia	Primary dealers should hold broad range of government securities constantly and are forced to participate in every auction of primary market.
Mexico	If obligations and benefits are not set right, the ranking index could give a competitive advantage to some intermediaries over others.
Poland	The danger of collusion when there are mainly: - fusion of banks in globalization environment - lack of competitiveness.
Thailand	If the primary dealers are not efficient, the liquidity injection and absorption of the central bank will not be successful.
Developing Countries
Armenia	No comment.
Ghana	PDs can consolidate and influence the market. The banks, as PDs, have products which are in competition with government securities and their commitment cannot be guaranteed.
Kenya	Collusion may occur where only few firms are accepted as PDs leading to lower auction prices and high intermediation costs passed onto the end investors.
Mauritius	PDs may buy securities with attractive yields and hold them instead of trading them.
Morocco	No comment.
Saudi Arabia	Possible manipulation of prices, if the size of the capital market is small and/or if regulatory guidelines are not sufficient to ensure a fair play.

Source: Survey of national authorities.

There is broad agreement among the respondents (87 percent overall approval) that primary dealers are recommendable, with 55 percent “strongly recommending” their presence and 32 percent just “recommending” their presence in the market for government securities (see Figure 3). Five percent “weakly recommend” the adoption of primary dealerships and 5 percent of the respondents think it is “not recommendable” to have primary dealers. The remaining 3 percent are uncertain.

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Recommendation of Primary Dealer System

Citation: IMF Working Papers 2003, 045; 10.5089/9781451846492.001.A001

Source: Survey of national authorities.

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Among advanced economies, 16 out of 19 “recommend” or “strongly recommend” the adoption of a primary dealer system, while the remaining 3 are “uncertain” or give no answer (Australia and New Zealand) or give a negative answer (Germany). Among the latter group, the view was expressed that at advanced stages of development primary dealers are not necessary, or are possibly harmful. Among emerging market economies, 11 countries out of 13 “recommend” or “strongly recommend” primary dealers, while Chile does not answer and Latvia thinks primary dealers are not recommendable. Among developing economies, all six countries “recommend” or “strongly recommend” the adoption of a primary dealer system.

In terms of supervision and enforcement of obligations, more that 15 countries reported the ministry of finance as main supervisor, and a few less mentioned the central bank, with several countries indicating shared responsibilities also with other agencies. Among advanced economies, nine review the primary dealer status on a 12-month basis, while Singapore, the United Kingdom, and the United States hold reviews every six months. Finland reviews the primary dealer status only when necessary; the remaining advanced economies have review periods longer than 12 months. Among emerging market countries, Argentina, India, Kazakhstan, Korea, and Thailand review primary dealer status every year, all the others have shorter review lags. A review period of six to 12 months can be considered standard practice among surveyed countries.

On the issue of primary dealership across stages of development, there seems to be a degree of consensus related to the presence of primary dealers in various phases of a country’s economic development: 38 percent of the answers indicated that it is recommendable to have primary dealers already in the early stage of economic development, and 15 percent indicated that it is always wise to have primary dealers (see Figure 4).

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Phases of Economic Development and the Establishment of Primary Dealership

Citation: IMF Working Papers 2003, 045; 10.5089/9781451846492.001.A001

Source: Survey of national authorities.

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