Club of bond traders loses cachet in most important market

Primary Dealers

Primary dealers are required to bid for no less than their pro-rata share at Treasury auctions -- 4.76% for each of the 21 dealers currently designated by the New York Fed. Bids must be “reasonable” compared with the range of prices in the so-called when-issued market before an auction, according to New York Fed rules. The dealers also provide market commentary and analysis helpful in conducting monetary policy and act as counterparties when the Fed buys or sells bonds.

Direct bidding was introduced more than a decade ago by then-Undersecretary of the Treasury Peter R. Fisher, according to Timothy S. Bitsberger, assistant secretary for financial markets at the time. Fisher thought the auctions should be free and open and that forcing institutions to route orders through primary dealers undermined that goal, Bitsberger said. Fisher, now at New York-based BlackRock, declined to comment.

“The system works well for the dealers if all the bidding is channeled through them,” said Bitsberger, now head of official institutions coverage at Paris-based BNP Paribas SA, a primary dealer. “On the other hand, the investors feel, why do they have to give up this information?”

Anonymous Bidders

The Treasury doesn’t reveal the identities of direct bidders. A February analysis by New York Fed Vice President Michael J. Fleming found that other dealers and brokers, investment funds and foreign investors have increased their participation in auctions. The share awarded to depository institutions, pension funds and individuals hasn’t changed.

One strategy for primary dealers is to sell Treasury debt to clients in advance with the intention of buying at a lower price at auction, said the traders. The strategy has failed in some cases when direct bids came at a higher price than dealers hoped to pay, saddling them with a loss, they said. That’s leading traders to become less aggressive in bidding and could result in higher yields at future auctions, some warned.

Dealer Appetite

Dealers have won 22% of the securities they have bid for this year through the end of March, compared with 26% in 2009, according to the Treasury data compiled by Bloomberg. Their share of the auctions has shrunk to 46.4% from 49% in 2009.

The Treasury hasn’t seen any indication that the increase in direct bidding has reduced primary dealers’ appetite at auctions, according to a senior official in the department. The official said firms are still applying for the designation.

Even with record debt, higher demand for U.S. Treasuries has helped suppress borrowing costs as a percentage of the country’s gross domestic product.

“Our basic view continues to be that having broad access to the auction process generates competition,” Matthew Rutherford, assistant Treasury secretary for financial markets, said in an interview.

Pacific Investment Management Co., the world’s largest active bond manager with $2 trillion, likes direct bidding because of the anonymity it offers and because it has reduced the price swings that used to occur before auctions as dealers reacted to the bids they received, said Steve Rodosky, who runs Treasury and derivatives trading at the Newport Beach, California-based firm.

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