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State Bank issues new Primary Dealers rules

KARACHI (July 06 2003) : The State Bank of Pakistan has allowed brokerage houses and investment banks to become 'Primary Dealers', besides commercial banks, to deal in government securities.

The central bank on Saturday issued Circular No 8 on new 'Primary Dealers Rules' to facilitate brokerage houses and investment banks to deal in securities.

Institutions desiring to become 'Primary Dealer' to conduct Government Securities business for the current year 2003-04 have been asked to send their applications to the Exchange & Debt Management Department, State Bank of Pakistan, Karachi, latest by July 12, 2003.

In order to make Primary Dealer system more broad-based and meaningful the following new Rules are being issued in super session of earlier Rules circulated vide EDMD Circular No 1 and EDMD Circular No 3 dated 19th June 2000 and 13th October 2000 respectively.

The salient features of the criteria, obligations and privileges of the Primary Dealers and other details under the new Rules are as under:

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 institution applying for Primary Dealership must have a minimum equity (net of provisions and capitalised losses if any) of PK Rs 500 million.

As an indication of strong managerial/trading capabilities, PD's treasury operations have to be fully computerised.

All PDs must also be equipped with standard treasury equipment including dealing terminals, phone recording systems, broker's hotlines, Telex/swift, Fax machines etc with telephone recordings 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.

At the time of scrutinising the application for PDs, State Bank of Pakistan may inspect on spot the above infrastructure of the applicant.

PDs would actively contribute in keeping the market liquid by their commitment to both primary & secondary markets. To win the status of PD, the applicant has to be a 'PRICE MAKER', quoting two-way price reflective of market sentiment and keeping trading window open throughout the day with active trading in all marketable Government securities.

While considering the application for PD, applicants' level of participation in the secondary market for the last one year would become a criterion to be selected as PD.<br>
B) Rules binding the status of a Primary Dealer

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, renewable every financial year, provided the PD continues to fulfil the existing criteria.

The renewals would be decided at least 30 days prior to the expiry of previous appointment.

As such, each PD shall be under obligation to submit request for reappointment at least two months prior to the expiry of tenure.

Alternatively, where a PD does not wish to continue as PD, it will have to inform the State Bank of Pakistan about its intention before the commencement of last quarter of his tenure.

The market would be intimated about a new appointee 30 days prior to its formal functioning as a Primary Dealer.

In case a Primary Dealer is found involved in activities not worthy of PD's status, the State Bank of Pakistan will serve it with a show-cause notice.

In case the explanation offered by the Primary Dealer is found unsatisfactory, his dealership shall be terminated with 30 days' notice period.

Appointment or termination of a Primary Dealer would be the sole discretion of the State Bank of Pakistan.

C) Primary Dealer's Privileges

Only PDs would be eligible to participate in the auctions of Govt. Securities. The requirement of other banks/institutional investors would be covered from these PDs or from other secondary market players.

However, PDs will sell the government securities to other banks and financial institutions after auction on the market prices. PDs will not be allowed to entertain passthrough bids.

In case a PD is unable to square its short position, the 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.

PDs would be allowed to carry a short position in securities managing it through repos up to a maximum of four consecutive weeks for bonds and one week for T-bills.

All security trading activity by the PDs in the secondary market shall be done in spot value unless specified otherwise. The spot value would be considered as T+2 working days.

PDs would deposit the funds to the S.B.P. B.S.C. (Bank) against their accepted bids on settlement date.

Since PDs would be the main source of market information for the regulators, the State Bank of Pakistan will regularly consult them in periodical meetings.

D) Primary Dealers' obligations

PDs would actively participate in all auctions of tradable government securities.

The State Bank of Pakistan would announce, maturity-wise, pre-auction target amount in long-term government securities. Non-competitive bids, however, as 10 percent of pre-announced auction target will be accepted by State Bank of Pakistan of investors other than banks/DFIs/NBFIs through PDs.

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 both for T-bills and long term paper would be confined to a range of +/- 50 paisa from the one prevailing on the last working day.

Each PD shall be required to ensure compliance of minimum underwriting target of 3.5 percent in case of long term paper over one year (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.

Each PD shall be eligible to claim underwriting commission to the extent of his underwriting amount as 3.5 percent of the target amount announced 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.

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.

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's determined immediately after the settlement date of the last auction of the respective fiscal year.

The rate of fee shall be reviewed after evaluating behaviour of market participants. The frequent non-compliance for underwriting requirements by PD may affect renewal of its primary dealership for next tenure.

It would be compulsory for all the PDs to quote their prices to other PDs, if the transaction volume is up to PK Rs 100 million subject to availability of limit.

For volumes other than that, there would be no mandatory requirement to quote a price. But in case of deals with other secondary market players eg Non-PDs, institutional investors etc each PD would quote two-way prices regardless of the volume, subject to availability of limit.

In the secondary market, all PDs would be bound to make prices within a maximum bid/offer spread of 50 paisa.

The quotes would be in price terms and not in terms of yield. The base price of a security would be considered in terms of 100 units, eg a price of 102/102.5 would depict bond price at a premium of 2 & 2.50 for bid and offer respectively.

To stir up activity in the Govt. paper, the rates would be regularly displayed by the PD on its Reuters pages on the news terminal and/or in the branches active in Government paper trading.

If the PD desires, it can also mention the volumes for which the rates would be applicable. For amounts exceeding the displayed volumes, the treasury may entertain its customers directly.

At any given day end, a PD's holding in a particular issue will not exceed 30 percent of the total issue amount and 15 percent for non-PD bank.

The PD will not be allowed to short-sell a particular issue more than 5 percent of the total issue amount, even during the 'When issued' period. However, short-selling will be allowed only up to announcement date of cut-off results in case of long term paper as well as in M.T. Bills.

In order to ensure a minimum level of compliance, certain reports will be required to be submitted to the State Bank of Pakistan on tradable securities on prescribed format.

Each PD shall be required to maintain separate book in respect of Govt Securities involving transaction through Primary Dealership.<br>
In case of listed brokerage houses they shall maintain a firewall between their brokerage and PD business.

E) Other details

The State Bank of Pakistan would announce the tenor-wise auction date and target amount of its long term paper 14 days prior to the auction date. The PDs would be allowed to carry out 'When issued' trading in that paper during the interim period of auction announcement and result dates.

All PDs shall submit their sealed bids to the State Bank of Pakistan by 10:00 am. In turn, SBP would announce the results positively by 3:00 pm on the same date.

Institutions who fulfil the criteria as laid down in Para A above and desiring to become Primary Dealer to conduct government securities business for the current fiscal year ie 2003-04 may send their applications latest by 12th July 2003 (Saturday) along with documents supporting their credentials.

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