All Head of Schedule Banks/DFIs/Investment Banks

Listed Brokerage Houses

Dear Sirs/Madam,

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

1. The applicant for the status of Primary Dealer (PD) must be a Bank / DFI / Investment Bank / Listed Brokerage House.
2. 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.
3. 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:

1. Dealing Terminals including Reuters and Bloomberg,
2. Phone Recording Systems,
3. Broker’s Hotlines,
4. Telex/Swift,
5. Fax machines,
6. 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.

4. Applicant must have adequate risk management systems to measure, manage and provide for the risks emanating from the PD activity.
5. 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.
6. Applicants’ level of participation in the secondary market for the last one year would also be a criterion for selection as PD.
7. 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.
8. 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.
9. 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:

1. Applications for appointment of Primary Dealers will be invited by State Bank of Pakistan each year via a circular.
2. All applicants, including existing PDs, shall submit an application for appointment as a Primary Dealer, accompanied by the documents referred to in the circular.
3. It will be binding for each applicant to furnish to the SBP any information as the SBP may consider necessary to assess the applicant’s suitability for appointment as a Primary Dealer.
4. Each new applicant will be evaluated in light of the selection criteria. Performance of existing PDs will be measured against performance benchmarks defined in these rules.
5. After an applicant is found fit by the State Bank of Pakistan, a letter will be issued for its appointment as Primary Dealer for a period of one year. However, SBP may also grant an applicant provisional/conditional status of Primary Dealer subject to periodic review.
6. The market will be intimated about Primary Dealer(s) appointment for the next financial year through a circular prior to their formal functioning as a Primary Dealer.
7. At any time during the financial year, if a Primary Dealer is found involved in activities not worthy of PD status or its performance falls below minimum benchmark levels, SBP may serve it with a show cause notice. If the explanation offered is found unsatisfactory, primary dealership could be terminated with a 30-day notice period.
8. Appointment or termination of a Primary Dealer is at the sole discretion of the State Bank of Pakistan.

C- Role of Primary Dealers:

1. 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.
2. Distribute Government securities to non-PD banks and other retail/institutional clients.
3. 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.
4. Act as a market maker in Government securities by quoting two-way prices in the market.
5. Continuously upgrade its infrastructure in terms of both physical equipment and skilled manpower for efficient participation in primary auctions and secondary market trading.
6. 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

1. 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. PDs must submit details of accepted pass-through bids to State Bank of Pakistan after every auction of Government securities.
2. 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 between 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 only if the auction is accepted.
   If a PD is unable to square its short position, it will be required to cover the short position from the market. Dependent on the liquidity position of the particular issue, State Bank of Pakistan may provide assistance at its discretion. SBP’s decision in this regard shall be binding.
3. 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. They are required to mark-to-market their short positions on a daily basis.
4. PDs will be allowed to submit Non-competitive Bids (NCBs) for both MTBs and PIBs. NCBs will be accepted up to 15% of the pre-announced auction target for investors other than banks (scheduled and specialized), DFIs, and Investment Banks through PDs. For non-competitive bidding, the ceiling for one investor will be linked with pre-auction target: 0.25% of the auction target or PKR 25 million, whichever is higher, subject to a maximum of PKR 250 million. Multiple bids breaching this limit will be treated as void.
5. PDs will have access to SBP Overnight Repo/Reverse-Repo Facility as per rules governing the operations of the interest rate corridor.
6. Each PD shall be eligible to claim underwriting commission up to the minimum underwriting target or the bid amount accepted, whichever is less, in respect of auctions of Long Term securities. The claim for commission shall be lodged by PD after the settlement date, with payment made annually.
7. The underwriting commission shall be paid at the rate of paisa 5 per Rs. 100, irrespective of maturities in long-term government securities sold in auctions.
8. PDs shall also be eligible to claim commission on NCBs at 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 shall be lodged after the settlement date, with payment made annually.
9. 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).
10. Since PDs are the main source of market information for regulators, SBP may consult them in periodical meetings as required. It is mandatory for PDs to provide information, feedback, or data to SBP on any particular issue to the best of their knowledge.

E- Primary Dealers’ Quoting and other Obligations

1. 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.
2. 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.
3. Each PD shall be required to ensure compliance with the minimum underwriting target of 3.5% applied on the Pre-auction target or the issued amount, whichever is lower, for respective tenors of PIBs (July - June). Compliance is not restricted on an auction-by-auction basis. Non-compliance may affect renewal of its primary dealership for the next year.
4. 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 a fee of 25 paisa per Rs. 100 of face value for the quantum of delinquency. The fee 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. Frequent non-compliance may affect renewal of its primary dealership for the next term.
5. It is compulsory for all PDs to quote two-way prices to other PDs, Non-PDs, and institutional investors as per instructions contained in rule E-6, subject to availability of limit.
6. In the 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-year tenor bonds. In case of MTBs, the maximum bid/offer spread for on-the-run issues will be 25bps.
   PDs have to ensure two-way prices in the secondary market within the above-defined maximum bid/offer spreads for marketable lot-size for both MTBs and PIBs. The marketable lot-size for MTBs will be in the range of PKR 100.0mln - 300.0mln (multiples of PKR 100.0mln). The marketable lot-size for PIBs will be in the range of PKR 50.0mln - PKR 200.0mln (multiples of PKR 50.0mln).
   On-the-run issues defined for the above obligation would represent the last two issues in the market. These instructions will also apply to PDs for quoting two-way prices on Electronic Bond Trading System (EBND) for MTBs/PIBs.
7. 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.
8. 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 1.5 billion, whichever is higher, in each tenor. 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 90 days from the last auction date of that particular issue. This revised limit applies only on issues sold during FY'08 and onward.
   Compliance with the above instructions on current holdings as on the date of this circular by PDs must be effectively met by 30 Sep 2012.
9. PDs shall segregate the Government securities of their customers from their own securities. In the case of a listed brokerage house, they shall maintain a firewall between their brokerage and PD business.

F- Performance Criteria

1. Each PD should ensure compliance with the minimum underwriting target of 3.5%, applied on the Pre-auction target or the issued amount, whichever is lower, for respective tenors of PIBs (July–June).
2. Each Primary Dealer should short-sell a minimum of 1.0% of the auction target of long-term paper during a year.
3. Each PD should bring a minimum of 5.0% of the NCB target of MTBs and PIBs during a fiscal year.
4. Each Primary Dealer’s turnover in the secondary market should be a minimum of 5.0% of overall market turnover (for PIBs and MTBs separately during the year). Out of this 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 entities other than Scheduled Banks and Primary Dealers.
5. To ensure that each PD is performing its obligation as a price maker on both sides, i.e., buying and selling of MTBs and PIBs, PDs should maintain a minimum 25:75 ratio on either side out of the above minimum turnover.
6. Each PD will ensure that at least 50% of its trading with other PDs is conducted through the Electronic Bond Trading System (EBND). This excludes transactions inputted via voice trade reporting mode (VTR).
7. Non-compliance with the performance criteria by a PD may affect its selection as Primary Dealer for the next year.