The primary dealers serve, first and foremost, as trading counterparties of the Federal Reserve Bank of New York (The New York Fed) in its implementation of monetary policy. This role includes the obligations to: (i) participate consistently as counterparty to the New York Fed in its execution of open market operations to carry out U.S. monetary policy pursuant to the direction of the Federal Open Market Committee (FOMC); and (ii) 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 in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.
This policy sets the standards for primary dealers (Standards). Each primary dealer must meet the Standards, initially and on an on-going basis. All primary dealers will be expected to engage in the traditional primary dealer functions listed above. All primary dealers will also be eligible to: (i) participate in the New York Fed's overnight securities lending program; and (ii) participate in such other operations, pursuant to their terms and as set forth in this policy, as may be available to primary dealers from time to time.1
The New York Fed continues to emphasize that the nature of its relationship with primary dealers is a counterparty relationship, not a regulatory one. This policy establishes the framework by which the New York Fed will prudently manage its counterparty risk consistent with its mandates to implement monetary policy and promote financial stability. The New York Fed also recognizes the value of maintaining transparency in its administration of its relationships with the primary dealers. In light of the foregoing, third parties are reminded that 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.
Finally, some of the activities associated with the primary dealer designation are not exclusive to primary dealers. Firms that are not primary dealers are permitted, but not required to bid directly in Treasury auctions. Firms that are not primary dealers may share market information with staff on the open market desk at the New York Fed about market conditions and other useful market color.
This policy includes four sections:
- Statistical Reports on Government Securities Activities
- Sanctions In The Event of Non-Compliance with Standards
- Application Process
The suggested form of written application for becoming a primary dealer is attached as an Appendix to this policy.
The New York Fed expects a primary dealer to:
- participate consistently as counterparty to the New York Fed in its execution of open market operations to carry out U.S. monetary policy pursuant to the direction of the FOMC;
- provide the New York Fed’s trading desk with market commentary and market information and analysis helpful in the formulation and implementation of monetary policy;
- participate in all auctions of U.S. government debt; and
- make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account holders.
In the selection process, the New York Fed will evaluate a prospective primary dealer with these expectations in mind.2 In this regard, a prospective primary dealer should be prepared to demonstrate to the New York Fed its activity levels in the various markets in which the New York Fed’s domestic trading desk transacts. A prospective dealer must be able to demonstrate an ability to provide sizable, sustained performance in operations in, at a minimum, the U.S. Treasury repo and cash markets, and preferably also in one or more other markets in which the New York Fed is eligible to transact. The New York Fed also prefers that a prospective primary dealer show underwriting capability in all such markets. Because Treasury auction participation is not limited to primary dealers, the New York Fed expects a prospective primary dealer to participate in Treasury auctions at levels expected of primary dealers (described below) prior to becoming a primary dealer.
In its ongoing evaluation of a primary dealer’s performance against these expectations, the New York Fed will look to the amount of business of various types transacted, the quality of the firm's participation, and the quality of the market commentary it provides to the New York Fed. Specifically, in evaluating participation in the New York Fed's repo operations, the New York Fed will expect a primary dealer to bid in every operation commensurate with its size, and its bid rates should be reasonable when compared to the range of rates in the market, taking into account market volatility and other risk factors. In other open market operations, the New York Fed will expect a primary dealer to bid, or otherwise participate, in operations at levels commensurate with its size and presence in the market.
Primary dealers should participate similarly in support of Treasury auctions: the New York Fed will expect a primary dealer to bid in every auction, for, at a minimum, an amount of securities representing its pro rata share of the offered amount, based on the number of primary dealers at the time of the auction. Its bid prices should be reasonable when compared to the range of rates trading in the when-issued market, taking into account market volatility and other risk factors.
Primary dealers that do little business with the New York Fed over a period of time, that repeatedly provide bids and offers in the New York Fed operations or Treasury auctions that are not reasonably competitive, or that fail to provide useful market information and commentary, are not meeting the New York Fed's expectations of a primary dealer. In those situations, the New York Fed may limit a primary dealer’s participation in any or all operations, and may suspend or terminate a primary dealer if it continues to fail to meet these business standards.
Responsible Counterparty and Market Participant
On an ongoing basis, the New York Fed expects primary dealers to act as responsible counterparties and market participants in their overall conduct and support of market efficiency and liquidity. Of note, the New York Fed expects its counterparties to have implemented the Best Practices for Treasury, Agency Debt, and Agency Mortgage-Backed Securities Markets published by the Treasury Market Practices Group (TMPG).3
The New York Fed may limit a primary dealer’s access to any or all operations, and may suspend or terminate a primary dealer if it fails to meet these behavioral standards of conduct or responsibility.
Financial Condition and Supervision
A primary dealer must be either a broker-dealer 4 registered with and supervised by the Securities and Exchange Commission (SEC) or a state or federally chartered bank or savings association (or a state or federally licensed branch or agency of a foreign bank) that is subject to official supervision by bank supervisors. The primary dealer must meet certain minimum capital requirements:
- A registered broker-dealer must have at least $150 million in regulatory net capital as computed in accordance with the SEC's net capital rule.5 The broker-dealer must also be in compliance with all capital and other regulatory requirements imposed by the SEC or its self-regulatory organization (SRO).
- A bank must meet the minimum capital standards to be considered ‘Well Capitalized’ or its equivalent by the applicable U.S. or foreign regulator, and must have at least $150 million of Tier I capital as defined in the applicable Basel Accord.
The New York Fed believes a minimum net capital requirement is a prudent element of its counterparty credit risk management. Given the business expectations of primary dealers and the meaningful securities positions that primary dealers may take as a consequence, a firm with lower capital will be unable to take such positions without significant leverage, which would increase the risk to the firm and to the New York Fed.
Note that these capital levels are minimum requirements. The New York Fed may impose a higher capital requirement as circumstances, in its judgment, warrant. For example, the New York Fed may impose a higher capital requirement upon primary dealer applicants with higher risk business or financial strategies or practices, or if a firm does not have significant parent or affiliate support. In general, the New York Fed must determine that an applicant’s financial condition can comfortably support the obligations of a primary dealer. In making this judgment, the New York Fed will conduct a credit review of the applicant and will consider various measures of the applicant’s financial condition.
The New York Fed may consult with the relevant bank supervisors, the SEC, the Commodities Futures Trading Commission (CFTC) and/or the relevant SRO, as applicable, regarding the primary dealer's maintenance of these capital standards. The New York Fed will not consider an application from a prospective primary dealer that does not meet these capital standards.The New York Fed will suspend or terminate the primary dealer relationship if a primary dealer fails to meet these capital or financial standards on an ongoing basis. In addition, the New York Fed may, consistent with ongoing prudent risk management and any applicable policy mandates, limit its exposure to all or certain primary dealers by capping or otherwise limiting activity with the New York Fed.
The New York Fed will consider an application from a prospective primary dealer only if it (1) has been a U.S. broker-dealer or bank (as set forth in section C above) for at least one year prior to the submission of the application and (2) has engaged in the business areas relevant to the functions of a primary dealer for at least one year prior to the submission of the application.
The New York Fed expects a primary dealer to have, or to have arrangements for another party to provide it the services of, a "back office" of sufficient size and experience to be able to (1) confirm and arrange settlement of transactions with the New York Fed and (2) manage trading at the volume levels expected by the New York Fed. A primary dealer must also:
- clear through one of the U.S. clearing organizations through which the New York Fed has a clearing relationship,
- establish the accounts and agreements with such clearing organization necessary for engagement in triparty repo/reverse repo transactions, and
- be a participant in the central counterparty service for the government securities market – DTCC’s FICC-GSD.
A primary dealer must also have a robust business continuity plan and be able to interface with the New York Fed, FICC-GSD, and its clearing organization from an alternate location staffed by trained personnel. Primary dealers’ disaster recovery capabilities, as reflected in their business continuity plans and routinely tested, should ensure that robust end-to-end participation in New York Fed’s trading desk operations and Treasury auctions (including trading, clearing and settling) will occur even amid a wide-scale disruption in the firm’s primary location by employing geographic dispersion between primary and secondary locations.
Compliance, Internal Controls, Legal and Regulatory Matters
The New York Fed expects a primary dealer to maintain a robust compliance program, including procedures to identify and mitigate legal, regulatory, financial, and reputational risks.6 Such program should include compliance professionals dedicated to the business lines relevant to the primary dealer functions and activities at the firm. The New York Fed may consult with the relevant bank supervisors or the SEC, the CFTC, the relevant SRO and other regulators, as applicable, regarding the firm’s control environment, as well as recent and pending regulatory and legal matters and any other matters the New York Fed deems relevant. Applicants will be expected to provide a letter directed to its regulators consenting to the provision of such information, including nonpublic information, to the New York Fed upon its request.
The New York Fed will not designate as a primary dealer any firm that is, or recently has been (within the last year) subject to litigation or regulatory action or investigation that the New York Fed determines material or otherwise relevant to the potential primary dealer relationship. In making such determination, the New York Fed will consider, among other things, whether and how any such matters have been resolved or addressed and the applicant’s history of such matters and will consult with the appropriate regulators for their views. In addition, with regard to existing primary dealers, the New York Fed may limit access to any or all operations, and may suspend or terminate a primary dealer relationship if a primary dealer becomes the subject of, or involved with, regulatory or legal proceedings that, in the judgment of the New York Fed, unfavorably impacts the primary dealer relationship.
If in the New York Fed’s judgment, a prospective primary dealer does not maintain a sufficiently robust control environment, its application may be declined. In the case of existing primary dealers, the New York Fed may limit access to any or all operations, and may suspend or terminate a primary dealer if it appears, in the New York Fed’s judgment, to have an inadequate or weak control environment.
Primary Dealers Act
Consistent with the Primary Dealers Act of 1988 (the Act),7 a foreign-owned dealer or bank may not be newly designated, or continue to be designated, as a primary dealer in cases where the Board of Governors of the Federal Reserve System (Board) and the New York Fed have concluded 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.
As of the date of this policy, the Board and the New York Fed have made affirmative determinations with respect to France, Germany, Japan, the Netherlands, Switzerland and the United Kingdom. In addition, firms controlled by persons domiciled in Canada and Israel are grandfathered under the Act.
Each primary dealer will be expected to agree to provide the New York Fed with any information deemed relevant by the New York Fed about the primary dealer or the primary dealer’s parent companies. Nonetheless, because of the quality and quantity of readily available financial information about public companies, the New York Fed prefers, but does not require, that the primary dealer (or the holding company of the primary dealer) be a public company. For non-public firms, the New York Fed requires timely delivery of quarterly financial statements, annual audited financial statements with notes, and other relevant disclosures. For public firms, the New York Fed requires the timely delivery of the same information if it is not publicly available on the company’s website.
II. STATISTICAL REPORTS ON GOVERNMENT SECURITIES ACTIVITIES
A primary dealer is expected to file the FR 2004 reports on an ongoing basis. The FR 2004 reports collect weekly data on primary dealers’ outright positions, transactions, and financing and fails in Treasury and other marketable debt securities. In addition, daily data is collected on positions in to-be-issued Treasury securities.8 This data is reported on the FR 2004WI report. Aggregate data is published on the New York Fed’s public website with a one week lag. More detailed information on the FR2004 report forms and instructions can be found at http://www.newyorkfed.org/markets/primarydealers.html.
III. SANCTIONS IN THE EVENT OF NON-COMPLIANCE WITH STANDARDS
The New York Fed may take action against any primary dealer that does not comply with the standards set forth in this policy. That action will vary depending upon the type of non-compliance, but may range, for instance, from suspension from any or all operations for a period of time to termination as a primary dealer.
IV. APPLICATION PROCESS
A firm wishing to become a primary dealer must submit an application to the New York Fed. The application is attached as an Appendix to this policy.
Prior to submitting a written application, firms considering whether to apply to become a primary dealer are encouraged to discuss the possibility with relevant New York Fed staff. Please direct inquiries to: PDInfo@ny.frb.org
Upon submission of a formal application, a prospective primary dealer can expect at least six months of formal consideration by the New York Fed.9 That consideration may include, among other things, on-site reviews of front, middle, and back office operations, review of compliance programs and discussions with compliance and credit risk management staff, discussions with senior management about business plans, financial condition, and the ability to meet the New York Fed’s business needs, review of financial information, and consultation with primary supervisors and regulators.
1 As appropriate, New York Fed will publish an addendum to this policy regarding special limitations on the availability of, or other unique terms pertaining to, any new and/or temporary operations or facilities otherwise generally available to primary dealers.
2 An applicant’s existing business should meet these business requirements such that becoming a primary dealer is a natural extension of that business. The business or business plan of a prospective primary dealer should not depend upon it being designated a primary dealer.
3 The Best Practices and more information about the TMPG can be found at http://www.ny.frb.org/tmpg/.
4 An entity that is only a government securities broker-dealer may also be eligible to become a primary dealer.
5 Securities and Exchange Act Rule 15c3-1, 17 C.F.R. 240.15c3-1.
6 For a description of best practices in compliance risk management see Federal Reserve Board of Governors, Compliance Risk Management Programs and Oversight at Large Banking Organizations with Complex Compliance Profiles, SR Letter 08-8 (Oct. 16, 2008), available at: http://www.federalreserve.gov/boarddocs/srletters/2008/sr0808.htm; see also Bank for International Settlements, Compliance and the Compliance Function in Banks (Apr. 2005), available at: http://www.bis.org/publ/bcbs113.pdf?noframes=1.
7 22 U.S.C. 5341- 5342.
8 On an ad hoc basis, daily information on a specific issue (Form SD) may be collected.
9 For a foreign-owned prospective primary dealer, if the jurisdiction in which its parent is domiciled has not previously been found to satisfy the Primary Dealers Act, this time frame may be adjusted, and may be significantly longer, depending on the timing and extent of further study of the home country.