Chapter 8. Evidence from the Survey

Marco Arnone, and Piero Ugolini
Published Date:
February 2005
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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 6 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 PD system, three are advanced economies (Australia, Germany, and New Zealand), four are emerging markets (Chile, Indonesia, Latvia, and Poland), and three are developing countries (Kenya, Mauritius, and Saudi Arabia).19

Figure 1.Year of Establishment of a Primary Dealer System

Source: IMF staff survey of national authorities (2001).

Countries with a system of primary dealership have a wide range of public debt/GDP ratios, but most of the countries without a PD system are at the lower level of the ratio. Figure 2 relates the presence of a PD system with the size of debt relative to GDP in the initial year of primary dealership.

Figure 2.Debt-to-GDP Ratio of Countries With and Without a Primary Dealer System, 1999

Fourteen (or 36 percent) of the respondents perceive a link between the size of public debt and the desirability of having a PD 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).

A. Reported Advantages and Disadvantages

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 PD system improves the coverage or 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 proper 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, Brazil, India, Kenya, Thailand, and the United States 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) (see Table 8).

Table 8.Survey of Advantages of a Primary Dealer System
Advanced Countries
AustraliaCan boost liquidity and development of the market. Primary issuance can be underwritten (to some extent).
AustriaProvides permanent services.
BelgiumReaches additional investors; can focus on placing and trading of debt, compensated by special rights.
CanadaEnsures 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 proper functioning of the Government of Canada securities market.
FinlandCommitted sales force, research, distribution of government debt.
FranceDecreasing market and refinancing risk; knowledge of the market; capacity for innovation; access to a wider sales force; and better promotion of the debt.
GermanyNo comment.
GreeceNo comment.
IcelandFour market makers are now, together with a primary dealer, obligated to take part in auctions and to give two-way quotes within a determined range. This leads to a better market price and increased price formation in the secondary market, and enhances the treasury’s access to the market. Turnover in the secondary market has increased.
IrelandReduces the cost of borrowing by providing a continuous two-way liquid market in government bonds; creates certainty in secondary market; eliminates illiquidity premium costs; allows debt to be restructured; acts as sounding board for changing debt strategy; facilitates closer organized contact with the investors.
ItalyFull 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 competent support in designing market-tailored securities.
NetherlandsEstablishes a core group of banks that compete to buy the issuer’s bonds, provides information on market movements and trends.
New ZealandNo comment.
NorwayWith two-way quotes the market always has price information, and better liquidity.
PortugalThe 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).
SingaporePlays 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; and

- foreign PDs with a global client base would be committed to attracting their investor clients to the developing bond market.
SpainAllows for a broad and efficient secondary market for government securities. With respect to the primary market, PDs ease the allocation of new issues.
SwedenIn 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 include fees to the PD.
United KingdomMore liquid market; easier to be transparent; easier auctions and settlement; reduced credit risk monitoring; easier distribution of securities.
United StatesFacilitates 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
ArgentinaEnsures the allocation of an important portion of public debt. It also specializes financial institutions dedicated to local market.
BrazilHelps the central bank in its function of keeping the market informed about the implementation of the monetary policy. Assists 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.
ChileBetter information and development of secondary markets; more liquid and deeper market for our debt instruments.
Czech RepublicStable structure of counterparts; easier administration and communication with market; transparent and reliable channel for cash and securities distribution; higher probability to sell securities.
HungarySecured base for sale of government securities; supports the secondary market of government securities; direct connection to and information exchange with market actors.
IndiaUnderwriting and market-making abilities exclusively in government securities market will be developed. Improved liquidity for government securities. Open market operations could be effective and operationally simpler once PDs become exclusive counterparties for central bank’s open market operations.
IndonesiaCan develop secondary market for government bonds and create market liquidity.
KazakhstanIt is easy to control and systemize primary market.
KoreaReduces the cost of government bond issue because a government does not have to pay underwriting fees; strengthens the demand base of the government bond; strengthens the stability of bond market by establishing leading market makers.
LatviaGenerates increase in liquidity and reduction in margins.
MexicoOffers increase in liquidity to the market.
PolandThere are several advantages, including

- reliability of financing state budget needs, even in single currency environment;

- liquidity and transparency of the government securities market;

- cost-effective financing; and

- the exchange of information about market and issuer policy.
ThailandEffective channel for conducting open market operations; has active market makers to enhance the liquidity in the secondary market; ensures successful outcome in the primary market auction.
Developing Countries
ArmeniaBetter participation in the auctions; higher liquidity of government securities market.
GhanaEnsures maximum participation in the auction. Allows relatively more market competition. Allows for a relatively vibrant secondary market.
KenyaProvides 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.
MauritiusActivates secondary market for treasury bills. Enables buyers and sellers to transact efficiently at prices reflecting fair values.
MoroccoOffers organization of the bond market, promotion of treasury bills, and exchange of information on available bids as well as the price levels at which the investors are willing to subscribe.
Saudi ArabiaEnhances market efficiency and liquidity along with creating active secondary market.
Source: IMF staff survey of national authorities (2001).
Source: IMF staff survey of national authorities (2001).

The strongest disadvantage of having a PD system that most countries noticed 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 underlined the importance of a careful balance between obligations and privileges. Brazil mentioned 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. Indonesia pointed out that if competitive behavior is not assured, price formation might not lead to a competitive market price. The United States 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 indicated no disadvantages of a PD system (see Table 9).

Table 9.Survey of Disadvantages of a Primary Dealer System
Advanced Countries
AustraliaMay discourage participation by some potential intermediaries not designated as PDs. Investors cannot directly purchase securities at time of primary issue.
AustriaNo comment.
BelgiumA 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.
CanadaRequires regular measuring and monitoring to ensure compliance with 1998 rules.
FinlandNo comment.
GermanyNo comment.
GreeceNo comment.
IcelandNone so far.
IrelandRecognition of commercial pressures that the PDs face.
ItalyRisk that the debt management policy may be sometimes influenced by views that are more biased toward PDs’ own interests than those of the sovereign issuer.
NetherlandsSo far, none.
New ZealandNo comment.
NorwayThe central bank must give some privileges to the PDs.
PortugalNo comment.
SingaporeIn a system where PDs receive privileges in return for fulfilling their obligations, this could create an uneven playing field vis-à-vis non-PD market participants.
SpainWe cannot see any disadvantages of having PDs.
SwedenNo comment.
United KingdomAdministrative burden, acquisitions of cartels, requires supervision.
United StatesThe designation of “primary dealer” is often viewed as giving the institutions a special status or guaranteeing their creditworthiness.
Emerging Markets
ArgentinaDifferences among participants (PDs) might limit competition.
BrazilPossibility of establishing unwilling links between the trading desk and a PD because of their daily contacts. Creation of some market inefficiencies and information asymmetry.
ChileLeaves out pension funds and insurance companies out of the debt auctions. Might be risky to depend on a small number of institutions that can fulfill the demands of a PD.
Czech RepublicUnder certain conditions other investors might be penalized for not being PDs by possible higher prices they may pay using the PD as intermediary. But it depends on the level of development of the market and the level of competition.
HungaryFree competition is limited in a way. Part of the debt financing depends on the performance of a limited number of market actors.
IndiaHighly dependent on short-term funding, making the money market volatile.
IndonesiaThis might be minor disadvantage: by having PDs, the price might not reflect the market price, so few participants can do securities transactions. The price seems determined only by PDs.
KazakhstanThere are no serious disadvantages of having PDs.
KoreaNothing particular.
LatviaPDs should hold a broad range of government securities constantly and are forced to participate in every primary market auction.
MexicoIf obligations and benefits are not set right, the ranking index could give a competitive advantage to some intermediaries over others.
PolandThe danger of collusion when there are mainly

- fusion of banks in globalization environment;

- lack of competitiveness.
ThailandIf the PDs are inefficient, the liquidity injection and absorption of the central bank will not be successful.
Developing Countries
ArmeniaNo comment.
GhanaPDs can consolidate and influence the market.

The banks, as PDs, have products that are in competition with government securities and their commitment cannot be guaranteed.
KenyaCollusion may occur where only a few firms are accepted as PDs, leading to lower auction prices and high intermediation costs passed on to the end investors.
MauritiusPDs may buy securities with attractive yields and hold them instead of trading them.
MoroccoNo comment.
Saudi ArabiaPossible manipulation of prices, if the size of the capital market is small and/or if regulatory guidelines are insufficient to ensure fair play.
Source: IMF staff survey of national authorities (2001).
Source: IMF staff survey of national authorities (2001).

B. Primary Dealers and Stages of Development

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.

Figure 3.Recommendation of a Primary Dealer System

Source: IMF staff survey of national authorities (2001).

Among advanced economies, 16 out of 19 “recommend” or “strongly recommend” the adoption of a PD 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 6 countries “recommend” or “strongly recommend” the adoption of a PD system.

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).

Figure 4.Phases of Economic Development and the Establishment of a Primary Dealer System

Source: IMF staff survey of national authorities (2001).

Informal primary dealerships might have been in place for some countries before formalizing the arrangement. Year of establishment of a PD system, indicated in Figure 1 as reported in the survey of national authorities, might therefore differ, depending on whether a formal, as opposed to factual, interpretation is adopted and on country-specific factors.

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