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Administration of Relationships with Primary Dealers
|January 22, 1992|
| The Federal Reserve Bank of New York (New York Fed)
is adopting certain changes in the administration of its relationship
with primary dealers in U.S. Government securities. The primary
dealer system has been developed for the purpose of selecting
trading counterparties for the Federal Reserve in its execution
of market operations to carry out U.S. monetary policy. The
designation of primary dealers has also involved the selection
of firms for statistical reporting purposes in compiling data
on activity in the U.S. Government securities market. These
changes in the administration of these relationships have been
developed after consultation with the Federal Reserve Board,
the Federal Open Market Committee, the Treasury and the Securities
and Exchange Commission.
The changes announced today have been prompted by two related factors:
The net result of these interrelated factors is that the Federal Reserve is amending its dealer selection criteria to begin providing for a more open system of trading relationships, while still exercising the discretion that any responsible market participant would demand to assure itself of creditworthy counterparties who are prepared to serve its needs.
For the most part, the changes in the administration of the primary dealer relationships will have no immediate effect on existing primary dealer--recognizing, of course, that they will, over time, be subject to the requirements noted below for maintaining a counterparty relationship with the Fed. However, existing as well as any new primary dealers will no longer be required to maintain a one percent share of the total customer activity reported by all primary dealers in the aggregate; this requirement is no longer deemed necessary given the active and liquid state of development now achieved in the U.S. Government securities market, and its retention could be an obstacle to achieving more open trading desk relationships. In addition, while continuing to seek creditworthy counterparties, and while continuing to exercise market surveillance, the New York Fed will discontinue its own dealer surveillance activities relating to primary dealer firms' financial characteristics.
New firms will be added on the basis of criteria listed below. As in the past, all primary dealers will be expected to (1) make reasonably good markets in their trading relationships with the Fed's trading desk; (2) participate meaningfully in Treasury auctions and; (3) provide the trading desk with market information and analysis that may be useful to the Federal Reserve in the formulation and implementation of monetary policy. Primary dealers that fail to meet these standards in a meaningful way over time will have their designation as a primary dealer discontinued by the New York Fed. It is contemplated that each dealer firm's performance relative to these requirements will be reviewed on an ongoing basis and evaluated annually beginning in June 1993. If a firm's relationship with the New York Fed is discontinued because of shortfalls in meeting these standards, the action by the New York Fed will be made strictly on a business relationship basis. As such, any decision by the New York Fed will carry no implication as to the creditworthiness, financial strength or managerial competence of the firm.
In evaluating a firm's market-making performance with the
trading desk, the New York Fed will look to the amount of business
of various types actually transacted and the quality of the
firm's market-making and market commentary. Dealers that do
little business with the Fed over a period of time, that repeatedly
provide propositions that are not reasonably competitive,
and that fail to provide useful market information and commentary,
add little to the Fed's ability to operate effectively and
will be dropped as counterparties for at least six months.
Finally, consistent with the Omnibus Trade & Competitiveness Act of 1988, a foreign-owned dealer may not be newly designated, or continue to be designated, in cases where the Federal Reserve concludes that the country in which a foreign parent is domiciled does not provide the same competitive opportunities to U.S. companies as it does to domestic firms in the underwriting and distribution of Government debt.
I. Criteria for Accepting New Dealers
A bank or a broker/dealer wishing to become a primary dealer, must inform the New York Fed in writing. As a part of that notification a prospective dealer must also provide appropriate financial data demonstrating that it meets the capital standards outlined above. The New York Fed will consult with the applicable supervisory body to ensure that the firm in question is in compliance with the appropriate capital standards. When new firms are accepted as primary dealers, the nature and extent of the Bank's trading relationship with the firm will, as under current practices, evolve over time. As a result of this change and the elimination of the one percent market share criterion, there will no longer be any need for individual firms to be considered by the market as "aspiring dealers."
Of necessity, at least for the time being, the number of additional primary dealers will be relatively limited, because of resource constraints on trading desk operations. The selection of this limited number will be dependent on how many can be added without adverse impact on the efficiency of Federal Reserve trading desk operations. Applications received by March 31, 1992, will be evaluated in relation to the foregoing capital standards. If it is not feasible to add all of the qualifying firms as primary dealers, a selection will be made among those firms in a manner that gives primary consideration to their relative capital positions. Following the implementation of automated communications for trading purposes, further expansion in the number of primary dealers will be feasible, and further changes in the criteria for selection also could be considered, although there is no preconception at this time as to what, if any, further changes would be made.
II. Maintenance of Capital Standards
III. Elimination of Dealer Surveillance
The elimination of the Bank's dealer surveillance activities should be viewed merely as confirmation of the long-standing reality that the Bank does not have--nor has it ever had--formal regulatory authority over the Government securities market or authority over the primary dealers in their capacity as such. The Bank is satisfied that the existing regulatory apparatus over the market and the regulatory apparatus as it applies to dealer firms is adequate--especially in light of changes outlined in the joint Treasury-SEC-Federal Reserve study--and it is satisfied that it can protect itself against financial loss without reliance on formal dealer surveillance.
IV. Sanctions of Primary Dealers for Wrongdoing
V. Statistical Reports on Government Securities Activities