Thursday, March 8, 2012

Primary Dealer System in India

The Beginning 


A system of market intermediaries in the form of Primary Dealers was made functional in 1996 with the objectives of supporting the market borrowing programme of the Government, strengthening the securities market infrastructure and improving the secondary market liquidity in government securities. PDs were also expected to encourage voluntary holding of government securities among investors. The PD system has created institutions whose basic interest is not to hold securities but to participate in primary auctions  to acquire securities and to use them  in the secondary market opeartions. PDs are responsible for ensuring the success of primary auctions. To discharge their obligations effectively, PDs have been given privileges in terms of provision of current account and SGL facilities with the Reserve Bank. They also have access to the liquidity adjustment facility (LAF) of the Reserve Bank. 


Prior to April 2006, the success of PDs in the primary auctions was ensured through a scheme of underwriting, and a system of bidding commitments and success ratios in the auctions. Underwriting commitments were separately decided prior to the actual auction for primary issuance, with the PDs bidding to underwrite various amounts at various commission rates. The Reserve Bank decided the actual allotment of the underwriting commitment, taking into account various factors such as the likelihood of devolvement and the commission sought. The full notified amount was rarely allotted in underwriting auctions. Since underwriting was a purely voluntary responsibility, the success of primary auctions was sought to be achieved through bidding requirements, which were set at the beginning of the fiscal year for each PD, depending mainly on its capital size. In order to ensure against defensive bidding, the stipulation of a success ratio of 40 per cent of bidding commitments was mandated. The performance of PDs in respect of bidding commitments and success ratios were monitored cumulatively over the year.



The PD system was revamped to ensure a more dynamic and active participation of PDs in view of the provisions of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003 whereby the Reserve Bank was prohibited from participating in the primary market effective April 1, 2006. In pursuance of the recommendation of the Technical Group on Central Government Securities Market, the Reserve Bank permitted banks to undertake PD business and also allowed banks having PD subsidiaries to merge them departmentally, subject to certain conditions. The Reserve Bank also issued revised guidelines for PDs to ensure that there is no under-subscription in the auctions. A new incentive structure in the underwriting auctions has been put in place to ensure 100 per cent underwriting and to elicit competitive bidding from PDs. The Reserve Bank has also revised the liquidity support facility to stand alone PDs based on their performance in the primary auctions and the turnover in the secondary market  Stand alone PDs have been permitted to diversify their activities in addition to their core business of government securities, subject to limits, so as to enable them to manage risk efficiently. There are 17 PDs at present, of which 11 are stand alone PDs and six are bank-PDs.

The presence of PDs in the government securities market has brought about an element of dynamism, both in the primary and the secondary segments. PDs have been actively participating in the auctions of government securities. By providing continuous two-way quotes, PDs act as market makers in the secondary market. The liquidity in the secondary market, in turn, lends support to the success of primary market operations. The PD system also facilitates open market operations of the Reserve Bank, besides taking over the responsibility of market making from the Reserve Bank.

A system of satellite dealers (SDs), as a second tier of dealer system in trading and distribution, was put in place in December 1996 to broaden the market and to impart momentum to the secondary market activity. SDs, with their good distribution channels, were expected to add depth to secondary market trading and widen the investor base through their retail outlets. The SD system was, however, discontinued from May 31, 2002 as it did not yield the desired results.


Sources of Information

Reserve Bank of India Bulletins

Master Circulars

July 2008


Developing The Indian Debt Capital Markets:Small Investor Perspectives, Working Paper, 2003, Planning Commission, India
Recent Trends in the Indian Debt Market and Current Initiatives: Presentation by RBI DG Rakesh Mohan, January 2006 2utb2lsm2k7a/ 985

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