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SEACEN/WB/IMF Conference Hosted by the Central Bank of Sri Lanka Colombo, June 2004 Thordur Jonasson
Financial Sector Operations & Policy Department
June 9, 2004
Structure of presentation
1. 2. 3. 4. Role of financial markets Primary market Primary dealers Market Making
Expectations of market participants may be dominated by memory of great volatility Credibility will be attained with consistency over time
Financial Sector Operations & Policy Department
Impact on Development
Issues
Ad-hoc or no debt
Result
Long-term Impact
management strategy Debt Management Weak capacity Accountability is unclear Access to Primary Market Debt Markets Illiquid money market Custody & Settlement problems
Higher Risk
Government budgetary pressures Higher Cost Higher cost of funds to productive sector, SMEs, etc. Less access to funds
Higher growth can be achieved by addressing the causes of unnecessarily high risk and cost
Regulation and supervision. - The Central Bank, - The Government - Self Regulatory Organizations
Market infrastructure - trading systems - information systems - brokers - clearing, settlement & custody
Primary dealers I
May assist change to a market-based funding environment
Branch networks (bank-based) Operators of mutual funds Business relationships with institutional investors such as pension funds and life insurance Links to off-shore investors
Primary dealers - II
There are no international standards for Primary dealers and the term itself can be misleading
Some financial systems may be less suitable for primary dealers
Will the introduction of primary dealers lead to deeper and more liquid markets? Rent seeking vs. gain from a more deeper liquid market? Can the arrangement be removed or reduced through competition in the future?
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Rights/Privileges
Exclusive counterpary rights for central banks omos and borrowing privileges with the central bank Exclusive access to primary aucitons Exclusive access to primary auctions Consultations with the debt management agency Exclusive access to primary auctions and noncompetitive bidding
Obligations
To bid in auctions. To make firm two-way quotes To report to the central bank To bid in auctions. To make two-way quotes To bid in auctions. To make firm two-way quotes. To report to the debt agency. To bid in auctions. To make firm two-way quotes. To trade a minimum of 2 percent of total secondary market volume
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New Zealand
Sweden 7 Exclusive access to primary auctions and counterparty to central banks omos
none
To bid in auctions. To report to the central bank. To contribute with good liquidity in the market
Thailand
UK
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USA
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Secondary market
Why should an issuer be concerned about secondary market activity?
The more liquid a security is, the easier and less costly it is for an investor to sell, and therefore the lower the liquidity premium attached to the security when issued Public good aspect
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INTERMEDIARIES
non pricemakers
pricemakers
Commercial Banks
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Market making
Market making is a risky business - assets can be bought / sold at short notice
Events may result in loss of liquidity In turbulent markets spreads widen, and in extreme cases price making may cease
Not all financial institutions may have the capacity to be market markets
Two-tier system
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Retail distribution
Labor intensive May require prepayment
Central bank
Financial Sector Operations & Policy Department
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Switches
Offered at the discretion of the debt manager or by reverse inquiry Sophisticated debt management tool
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Investor base
Small institutional investor base not motivated to manage their risks or a reasonable sized investors base but concentrated
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No hedging mechanisms
no access to rental securities undeveloped repo markets
Taxes
eg taxes based on original discount value, transaction taxes, withholding taxes
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Some countries have not found it necessary to introduce a primary dealer system
Financial Sector Operations & Policy Department
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It is not given that primary markets for Tbills and Tbonds should be treated alike The government has an important role to play both as the client and as the regulator and supervisor
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Thank you!
Questions/comments/suggestions to:
Thordur Jonasson tjonasson@worldbank.org (202) 458-2165
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