WASHINGTON -- The recent rash of changes in the nation's Treasury securities trading system could trigger an exodus of primary dealers, a Public Securities Association panel warned in an evaluation of the government securities market released Friday.
That exodus could leave behind a relatively small group of dealers that is more homogenous than the Federal Reserve intended, the panel, whose chairman is Stephen Thieke, president of J.P. Morgan Securities, said in its paper.
Thus, it may be preferable for Washington to change the system formally before market forces lead to the firms' "self-elimination," the group warned.
"With the exception of the designation itself, all of the special privileges which have accompanied the responsibilities of being a primary dealer are in the process of being removed as a result of changes to the auction process, broadened access to market information, and broadened trading access on interdealer brokers' screens," the panel's paper says.
It added, however, that if the decision is made to alter the current system significantly, the transition problems could be "formidable." But automation would smooth the way, it said. Thus, it would be prudent to dealy radical changes until after auctions are automated, the panel said.
The Treasury announced on Oct. 27 major rule changes in the auction process for U.S. government securities, including measures designed to open up sales to all registered broker-dealers who bid on behalf of customers.
It also set up a payment mechanism that will enable any bidder to participate in government securities auctions without making a deposit or payment guarantee and raised the maximum amount of notes and bonds that a single non-competitive bidder may receive at an auction from $1 million to $5 million.
The panel said its paper does not argur for or against the current system. Rather, it presents conclusions the PSA hopes the Federal Reserve Board, the Treasury, and the Securities and Exchange Commission will find useful as they study possible changes to the Treasury's current system for auctioning government securities. The agencies are expected to send their reports to Congress by the middle of January.
If liquidity and orderly distribution of securities are federal regulators' top priorities for the U.S. Treasury securities market, then the current primary dealer system is quite effective, the panel said.
But if regulators are more interested in maximum access for all potential participants in the market and minimal government interference, then it may be preferable to change the system, it said.
But the panel noted that the first of the two ssets of criteria -- liquidity and orderly distribution -- mean the lowest possible cost for financing federal debt.
"The U.S. could operate without the primary dealer system," the group said. "However, the ramifications of such a change are largely unpredictable. Each market participant would have to assess dealers on their own merits and to limit credit exposure, much the way they do now with regard to non-primary dealer counterparties."
The group said that whether the system is formally changed or not, the Federal Reserve might consider reducing or eliminating its dealer surveillance activities. "It has become evident that those activities have led market participants and the public generally to hold unrealistic expectations of the Federal Reserve's ability to prevent problems at primary dealers."
The panel issued a set of "guiding principles for evaluating policy and procedural changes in the treasury securities market" and said additional issue papers analyzing auction methods, rights, and responsibilities in the auction process and large-position reporting are being developed.
In one principle, the PSA said Congress and regulators should consider the impact of any changes they are contemplating on the nation's ability to compete globally.
Also Friday, a PSA task force on government-sponsored enterprise debt sales issued a report and recommendations for improving the way bank and nonbank dealers sell and distribute federal agency debt.
