An Enabling Environment for an effective Primary Dealer system – Morocco Johan Krynauw – Programme Manager – Sustainable Public Debt Management 1
Objective and rational of a primary dealer system PDs are financial intermediaries appointed by a DMO to perform certain specialized functions in the government securities market . The PDs and the DMO pursue a common strategy to support funding of the government and development of the market. Primary dealer system can make substantial contributions to the development of the market when its establishment is appropriate for prevailing market conditions. While by no means a precondition for a well functioning government securities market , primary dealers know the market best and are the counterpart of the investors who are the debt management office’s ultimate target Gemlock advisory services – paper on primary dealer systems http://siteresources.worldbank.org/FINANCIALSECTOR/Resources/Primary_Dealer_Systems_Handbook.pdf
Primary dealers - considerations • The development of government bond market involves a broader set of policies than just establishing a PD system. • Designing a well-performing PD system remains nonetheless a complex process • It is hard to over-estimate the importance of the contribution that PDs can deliver when the appointment of PDs is appropriate for the conditions present in the market • There are some preconditions for a PD system to work. • Why factor…..
Benefits of having a primary dealer system • Reduce market and refinancing risk for government ✓ Large % of government funding requirement is effectively underwritten by primary dealers • Improve liquidity and efficiency of the bond market • With two way price quote, the market always has price information • Improve market analysis and research
Preconditions – essential prerequisites – managing primary dealers • Enabling environment as established by the Public Debt Office • Well-functioning secondary market for government bonds
Funding options – annual funding strategy Domestic short term loans • Treasury bills etc. (3m, 6m and 12months) Domestic long term loans • Marketable bonds (2y and longer) • Retail bonds • Active debt management – Switches, buy backs, consolidation Foreign loans • Marketable • Non marketable
Building and lengthening the yield curve Considerations - • Address refinancing risks - avoiding concentration at the short end • Standard marketable government securities as main funding instrument (coupon, yield, maturity) • Other bonds, infrastructure, green bonds, SUKUK, floating rate notes, zero coupon bonds should be issued with caution – could fragment the market • When is a bond considered as liquid – volume/size? • Pricing of new bonds – first time issuances (coupon = yield) • Three legged bonds – South Africa phenomena
Building and lengthening the yield curve – South African maturity profile
Building and lengthening the yield curve – buy side perspective • Commercial Banks – usually largest captive source of funding – but banks should not hold bonds, other than for liquid assets purposes • Pension funds – long term liabilities, seek assets to match • Mutual funds – play active role in buying gov. short and long term securities • Non financial corporations – (corporates) – mainly short term • Foreign investors - . bring price efficiency through increased competition and contribute to liquidity and the extension of the government bond yield curve
Introducing and maintaining liquid bench marked bonds • Clean up the yield curve from small illiquid bonds • Consolidation or switch programme • Establish bench marked bonds across the yield curve (2, 5, 10, 15 and 20 year) • Investors appetite for longer dated bonds – influence by country rating and/or risks profile • Investor’s perceptions to be addressed • Pension fund and insurance reforms – broadening the investor base
Introducing and maintaining liquid bench marked bonds • Build size/volume in a bond - regular tap issuances • New bonds – primary dealer only obliged to make market if bond reach a certain volume/size (RSA – R10 billion) • Creating demand for bonds, understanding what influence demand factors
Primary auction calendar
Efficient secondary markets • Requires diversified participants. • Benefits of primary dealership is greater when there are many investors. • Large benchmark standardised bond issues. • Permissible transactions should include spot, repo, forward, short-selling, and securities lending. It could also include switches, strips, futures and options. • Standardised conventions for pricing, trading units, settlement, etc. • It can be a quote driven market or an order driven market or a hybrid. Government bonds tend to be quote driven.
Pillars for developing local currency bond markets • Macro economic environment ✓ Stable, transparent and prudent policies • Money market ✓ monetary policy plays a key role ✓ Government cash management system ✓ Clear interest rate bench marks • Primary market ✓ Transparent and predictable issuance process ✓ Tapping of existing bonds, buybacks and switches ✓ Coordination between central bank and government on instrument used for funding and monetary policy
Pillars for developing local currency bond markets • Investor base – broad and diversified investor base • Secondary markets ✓ Benchmarks ✓ Ability to trade spot, short and repos ✓ Standardise conventions ✓ Price transparency in pre - and post trade ✓ Adequate regulation of market participants and behaviour • Custody and Settlements – DvP, low cost structure, CSD and exchange, • Debt market regulation and exchange rules
Government as lender of last resort • As lender of last resort the Ministry of Finance has an obligation to support bond market to avoid settlement failure • It an overnight facility at zero interest rate (could negotiate an interest rate payable on collateral as deposit • Only provide script if all other avenues of obtaining script in the bond market has failed • Facility is available strictly to primary dealers and member of the stock exchange
Thank you
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