DMMD Circular No. 12 of 2012
All Head of Schedule Banks/DFIs/Investment Banks
Listed Brokerage Houses
Master Circular-Rules Governing Primary Dealer System
Please refer to EDMD Circular no. 11 dated August 27, 2005 and FSCD Circular no. 07 dated June 06, 2009 in which rules governing Primary Dealer system were stipulated.
In order to streamline and further strengthen the Primary Dealer system, few amendments have been made in the rules governing this system. Purpose of these amendments has been to create a balance between privileges and obligations of Primary Dealers (PDs) to achieve the objective i.e. development of debt market in Pakistan. In addition to the above, instructions issued from time to time on the subject have also been consolidated in this master circular.
A- Selection Criteria
- The applicant for the status of Primary Dealer (PD) must be a Bank / DFI / Investment Bank / Listed Brokerage House.
- As a measure of financial stability, the Banks/DFIs applying for Primary Dealership must have met the minimum paid-up capital requirement of State Bank of Pakistan as of last financial year end. All other applicant should have minimum equity (net of provisions and capitalized losses if any) of PKR 1,000 million.
- As an indication of strong managerial /trading capabilities, applicant’s treasury operations have to be fully computerized. All applicants must also be equipped with standard treasury equipment including:
a. Dealing Terminals including Reuters and Bloomberg,
b. Phone Recording Systems,
c. Broker’s Hotlines,
e. Fax machines,
f. Telephone recording equipment with records retained for a period of 90 days.
To ensure competent and knowledgeable staff, a minimum of five years of relevant professional experience would be required for main treasury / front office and back office personnel.
- Applicant must have adequate risk management systems to measure, manage and provide for the risks emanating from the PD activity.
- All PDs will have to adhere to quoting obligations as specified by State Bank of Pakistan from time to time. To secure the status of PD, the applicant has to be a “PRICE MAKER”, quoting two-way price keeping trading desk open throughout the day for marketable Government securities.
- Applicants’ level of participation in the secondary market for the last one year would also be a criterion for selection as PD.
- An applicant applying for PD status must display complete information regarding process, methodologies, charges and forms required for investment in Government securities, on their official website.
- Charges imposed by the applicant on Investor’s Portfolio of Securities Account should be reasonable and in line with SBP’s objective to broaden the investor base of Government securities.
- At the time of scrutinizing the application for PDs, State Bank of Pakistan may conduct on-site inspection to ensure compliance of aforesaid requirements.
B- Selection Process:
- Applications for appointment of Primary Dealers will be invited by State Bank of Pakistan each year vide a circular. All applicants including existing PDs shall submit an application for appointment as a Primary dealer and shall be accompanied by the documents referred to in the circular. It will be binding for each applicant to furnish to the SBP any such information as the SBP may consider necessary for the purpose of considering the suitability of the applicant to be appointed as a Primary Dealer.
- Each new applicant will be evaluated in the light of the selection criteria. However, performance of existing PDs will be measured against performance benchmarks defined in these rules.
- After an applicant is found fit by the State Bank of Pakistan, a letter would be issued for its appointment as Primary Dealer for a period of one year. However, State Bank of Pakistan may also grant an applicant provisional/conditional status of Primary Dealer subject to periodic review.
- The market would be intimated about Primary Dealer(s) appointment for next financial year through a circular prior to their formal functioning as a Primary Dealer.
- At any time during the financial year, if a Primary Dealer is found involved in activities not worthy of PD’s status or its performance has been found below minimum benchmark levels, the State Bank of Pakistan may serve it with a show cause notice. In case, the explanation offered by the Primary Dealer is found unsatisfactory, primary dealership could be terminated with a 30 days notice period.
- Appointment or termination of a Primary Dealer would be the sole discretion of the State Bank of Pakistan.
C- Role of Primary Dealers:
- Primary Dealers are required to:
- Actively participate in the primary market by bidding in the auctions of Government securities as conducted by State Bank of Pakistan from time to time.
- Distribute Government securities to non-PD banks and other retail/institutional clients.
- Play an active role in secondary market development to enhance liquidity and turnover, and to widen the investor base of Government securities by creating awareness among investors.
- Act as a market maker in Government securities by quoting two-way prices in the market.
- Continuously upgrade its infrastructure in terms of both physical equipment and skilled manpower for efficient participation in primary auctions and secondary market trading.
- Provide efficient custody services to its customers (Investors Portfolio of Securities Accounts) for Government securities holding, collection and, payment of profits & maturity proceeds.
D- Primary Dealer’s Privileges
- Only designated PDs would be eligible to participate in the auctions of Government Securities. The requirement of other banks and institutional/retail investors would be covered from these PDs or from other secondary market players.
PDs will be allowed to entertain Pass-through bids, but such volumes will not be counted towards secondary market performance evaluation of the respective PD. However, PDs have to submit detail of accepted pass-through bids to State Bank of Pakistan after every auction of Government securities.
- The State Bank of Pakistan would announce the auction date and tenor wise auction target of GoP's long term paper 14 days prior to the auction date. PDs would be allowed to carry out “When issued” trading in that paper during the interim period of auction announcement and auction time.
The PD will not be allowed to short sell a particular issue more than 5% of the total target amount, during the “When issued” period. Short selling will be allowed only up to the time of auction and will be available only if the auction is accepted.
In case a PD is unable to square its short position, PD will be required to cover the short position from the market. However, dependent on the liquidity position of the particular issue State Bank of Pakistan, at its discretion, would help using various options depending upon the situation. Decision of the State Bank of Pakistan in this regard shall be binding.
- Only PDs would be allowed to carry a short position in securities managing it through repos up to a maximum of three consecutive months for bonds and two weeks for MTBs. However, they would be required to mark-to-market their short positions on daily basis.
- PDs will be allowed to submit Non-competitive Bids (NCBs) for both MTBs and PIBs. Non-competitive bids will be accepted as 15% of the pre-announced auction target by the State Bank of Pakistan for investors other than banks (both scheduled and specialized)/ DFIs/ Investment Banks through PDs. However, for non-competitive bidding, the ceiling for one investor will be linked with pre-auction target i.e. 0.25% of the auction target or PKR 25.0million, whichever is higher, subject to a maximum of PKR 250 million. In case of breach of this limit through submission of multiple bids in one tenor, all such bids would be treated as void.
- PDs will have access to SBP Overnight Repo/Reverse-Repo Facility as per rules governing the operations of interest rate corridor.
- Each PD shall be eligible to claim underwriting commission, to the extent of minimum underwriting target (as explained in rule E-3) or the bid amount accepted, whichever is less, in respect of auction of Long Term securities. The claim for underwriting commission shall be lodged by PD after the settlement date however, commission will be paid annually.
- The underwriting commission shall be paid to PD at the rate of paisa 5 per Rs. 100 irrespective of maturities in long term government securities sold in auctions.
- PDs shall also be eligible to claim commission on NCBs @ 10 paisa per Rs. 100 applicable only on accepted NCBs of Individuals/Employee, Provident & Pension Funds/Corporate except AMCs, Mutual Funds, Insurance, Modaraba and Leasing companies, in MTB and PIB auctions. The claim for the commission shall be lodged by the PD after the settlement date however, commission will be paid annually.
- Top three performing PDs (based on their performance against benchmarks defined in these rules) will be announced by State Bank of Pakistan at the end of each year (July-June).
- Since PDs would be the main source of market information for the regulators, State Bank of Pakistan may consult them in periodical meetings as and when required. It will be mandatory for PDs to provide information/feedback/data to SBP on any particular issue to the best of their knowledge.
E- Primary Dealers’ Quoting and other Obligations
F- Performance Criteria
- PDs must actively participate in all auctions of tradable Government securities. The State Bank of Pakistan would announce pre-auction target amount in short-term as well as in long-term government securities.
- An important responsibility of the PD will be to underwrite the auctions of Long-term paper offered by the State Bank of Pakistan. To avoid any out of market quotes the bid price for long-term paper would be confined to a range of + 50 basis points from the respective tenor prices appearing on Reuters PKRV page on the last working day prior to bidding.
- Each PD shall be required to ensure compliance of minimum underwriting target of 3.5% to be applied on the Pre-auction target or the issued amount, whichever is lower, for respective tenors of PIBs (July - June) and compliance to this shall not be restricted on each auction basis. The non-compliance for underwriting requirements by PD may affect renewal of its primary dealership for next year.
- If a PD fails to meet its underwriting commitment in respect of long term paper, fully or partially during the prescribed period it shall be liable to pay fee of 25 paisa for Rs. 100 of face value for the quantum of delinquency. It shall be determined immediately after the settlement date of the last auction of the respective fiscal year. The rate of fee shall be reviewed after evaluating behavior of market participants. The frequent non-compliance for underwriting requirements by PD may affect renewal of its primary dealership for next term.
- It would be compulsory for all the PDs to quote two-way prices to other PDs, Non-PDs, and institutional investors etc. as per instructions contained in rule E-6, subject to availability of limit.
- In secondary market, all PDs may quote in terms of yield rather than price. In case of PIBs, the maximum bid/offer spread will be 15bps for on the run issues up to 10 years tenor bonds. In case MTBs, the maximum bid/offer spread for on the run issues will be 25bps.
PDs have to ensure two-ways prices in secondary market within above defined maximum bid/offer spreads for marketable lot-size for both MTBs and PIBs. The marketable lot-size for MTBs will be in range of PKR 100.0mln - 300.0mln (multiples of PKR 100.0mln).The marketable lot-size for PIBs will be in range of PKR 50.0mln - PKR 200.0mln (multiples of PKR 50.0mln).
On-the-run issues defined for above obligation would represent last the two issues in the market. These instructions will also be applicable on PDs for quoting two-way prices on Electronic Bond Trading System (EBND) for MTBs/PIBs.
- PDs will be responsible for displaying the prices of Government securities on Reuters/Bloomberg/EBND and in branches. Quoting obligations must be strictly adhered to.
- At any given day, a PD's holding in a particular issue with days to maturity greater than 1-year will not exceed 30.0% of the total issued amount or PKR 1.5billion, whichever is higher in each tenor. However for Non-PDs the limit will be 15.0% or PKR 1.5 billion, whichever is higher, in each tenor. The PDs issue-wise holding limit of 30.0% will run-down to 15.0% of the issued amount on expiry of 90days from the last auction date of that particular issue. This revised limit would apply only on issues sold during FY'08 and onward.
Compliance to above instructions on current holding as on date of this circular by PDs, be effectively met by 30Sep2012.
- PDs shall segregate the Government securities of its customers from its own securities. In case of listed brokerage house, they shall maintain a firewall between their brokerage and PD business.
- Each PD should be required to ensure compliance of minimum underwriting target of 3.5% to be applied on the Pre-auction target or the issued amount, whichever is lower, for respective tenors of PIBs (July-June).
- Each Primary Dealer should short-sell a minimum of 1.0% of auction target of long term paper during a year.
- Each PD should bring a minimum of 5.0% of the NCB target of MTBs and PIBs during a fiscal year.
- Each Primary Dealer’s turnover in secondary market should be minimum 5.0% of overall market turnover (for PIBs and MTBs separately during the year). Out of the minimum turnover of 5%, at least 1% (for PIBs and MTBs separately) of total turnover should be with non-banks. For the purpose of this rule non-bank means other than Schedule Banks and Primary Dealers.
- Further, to ensure that each PD is performing its obligation as price maker on both sides, i.e., buying and selling of MTBs and PIBs, out of the above minimum turnover; PDs should ensure a minimum of 25:75 on either side.
- Each PD will ensure that at least 50% of its trading with other PDs should be through Electronic Bond Trading System (EBND). This would not include transactions inputted via voice trade reporting mode (VTR).
- Non-compliance of performance criteria by PD may affect its selection as Primary Dealer for the next year.
Sr. Joint Director