Poor primary dealers.
They are the official trading partners of the Federal Reserve Bank of New York, currently numbering 18, but they’ve had to contend with some difficult newsflow in recent weeks.
For a start, the Federal Reserve decided last week to change its requirements for PDs, raising the net capital requirement for banks to $150m from $50m. This prompted speculation that the Fed was preparing itself for a sudden rush of applications for PD status, eager to take advantage of things like record Treasury issuance and the Primary Dealer Credit Facility.
Then, lo and behold, at least three non-US banks were outed as wannabe-PDs last week.
But is the rush to PD-status coming at exactly the wrong time?
Recall that there are three categories of bidders at Treasury auctions: PDs, the historical counterparties for the Fed, indirect bidders, which are Treasury-buyers who bid through PDs, and direct bidders, who bypass the PDs and bid directly (duh).
Two of last week’s big four Treasury auctions saw a spike in direct bidding, prompting speculation of a single large bidder, or a more long-term, structural shift in demand for US Treasuries. We’d also note that growing use of the Treasury Automated Auction Processing System (TAAPS) , which enables any institution to place bids themselves online, may be having an impact too.
Here’s Deutsche Bank’s Marcus Huie on the rise of direct bidding:
Because any institution can bid through TAAPS, it isn’t clear which category of institution is actually shifting its bidding away [from indirect bidding mostly]. We can examine the auction allotment data published by the Treasury, but the results are inconclusive. From the auction allotment data, there are only 3 categories of bidders who make up most of nearly every auction: Dealers and brokers, Investment funds, and Foreign and international. The first category can include both primary dealers, and broker/dealers who aren’t primary dealers yet but might be seeking to apply for primary dealership status. Foreign and international could include foreign central banks, commercial banks, or investment managers. An increase in direct bidding often has no corresponding shift in the auction allotment data. Sometimes there is a relationship, but it can’t be identified with one particular category. For example, the record rise in 2Y direct bids last October, amounting to an increase of $7 bn in direct fills, was reflected in the allotment data by a $2 bn increase from investment funds and $5 bn from foreign and international. But the rise in direct bidding in the 10Y from October through December wasn’t related to a consistent increase in any one category.
Thus it appears that direct bidding may come from any of the 3 principal categories, and means that a range of customers are increasingly bypassing the primary dealers. This trend could raise the cost for primary dealers of participating in auctions, since they no longer see the information content of customer flows. In combination with the raising of capital requirements for primary dealers, to $150 mm from $50 mm, primary dealership is on the margin slightly less attractive. This has not been reflected in recent auction statistics, however, since primary dealer participation remains high. In the long term, however, this might lead to more volatility in auctions.
Current primary dealers, for those interested: BNP Paribas, Bank of America, BarCap, Cantor Fitzgerald, Citi, Credit Suisse, Daiwa, Goldman Sachs, HSBC, Jefferies, JP Morgan, Mizuho, Morgan Stanley, Nomura, RBC Capital Markets, RBS, UBS, and, err, Deutsche Bank.
Related links:
Treasury Mystère – FT Alphaville
Who buys Treasury securities at auction – Federal Reserve
Smoke, mirrors and Treasury sales – FT Alphaville