Revised Policy for Administration of Primary Dealer Relationships: Frequently Asked Questions

January 11, 2010

What are the functions of primary dealers?
Primary dealers serve, first and foremost, as trading counterparties of the Federal Reserve Bank of New York. This role includes the obligations: (i) to participate consistently as a counterparty to the New York Fed in its execution of open market operations as directed by the Federal Open Market Committee (FOMC), and (ii) to provide the New York Fed's trading desk with market information and analysis helpful in the formulation and implementation of monetary policy. Primary dealers are also required to participate meaningfully in all auctions of U.S. government debt, including an underwriting commitment, and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.

Why has the New York Fed adopted a revised policy for the administration of relationships with primary dealers?
The revised policy takes into consideration the evolution of the marketplace and of open market operations over the past decade, as well as recent changes in the role of primary dealers. The intent of the policy is to be more transparent about the significant business standards expected of primary dealers, and to provide clearer guidance regarding the process of becoming a primary dealer. The business standards in the revised policy represent a formalization of existing practice that has accumulated over time and do not represent new standards expected of primary dealers.

Will the New York Fed apply this policy to existing, as well as prospective, primary dealers?
Yes.

What are the substantive changes incorporated in the new policy?
The major differences between the revised policy and the prior one include a more structured presentation of the business standards expected of primary dealers, a more formal application process for aspiring dealers, an increase in the minimum net capital requirement from $50 million to $150 million, a seasoning requirement of one year of relevant operations before a prospective dealer may submit an application, and clear notice that the New York Fed may take any number of actions against a noncompliant dealer. In addition, aspiring dealers must satisfy operational, compliance, legal, and regulatory requirements consistent with prudent counterparty risk management and the needs of the New York Fed.

Why was minimum capital threshold to become a primary dealer increased from $50 to $150 million?
This change reflects the proportional increases in gross U.S. Treasury debt issuance and the size of the U.S. Treasury market, as well as the evolution of open market operations since the policy was last updated in 1992. The New York Fed believes a minimum net capital requirement is a prudent element of its counterparty credit risk management. In light of the significant business expectations of primary dealers and the meaningful securities positions that primary dealers may take as a consequence, the New York Fed retains flexibility to require higher capital where circumstances warrant (e.g., if a dealer has a riskier business model or does not have significant support from a parent or affiliate).

What is the purpose of the one year seasoning requirement before prospective dealers may submit an application?
The seasoning requirement ensures that prospective dealers have a track record of relevant experience on which an assessment of the firm’s operational performance, control environment, and compliance record may be based. Becoming a primary dealer should complement a prospective dealer’s business plan; it should not be the defining attribute of the business plan.

Are primary dealers regulated by the New York Fed?
No. The nature of the New York Fed’s relationship with primary dealers is a counterparty relationship, not a regulatory one. The designation of an entity as a primary dealer by the New York Fed in no way constitutes a public endorsement of that entity by the New York Fed, nor should such designation be viewed as a replacement for prudent counterparty risk management and due diligence.