A primary dealer is a pre-approved bank, broker-dealer, or other financial institution that is able to make business deals with the U.S. Federal Reserve, such as underwriting new government debt. These dealers must meet certain liquidity and quality requirements as well as provide a valuable flow of information to the Fed about the state of the worldwide markets.
BREAKING DOWN Primary Dealer

Primary dealers are a system of banks and broker-dealers authorized by the Federal Reserve System to deal directly in government bonds. This system was established in 1960 by the Federal Reserve Bank of New York (FRBNY) to implement monetary policy on behalf of the Fed. By purchasing securities in the secondary market through the FRBNY Open Market Desk, the government increases reserves in the banking system and, thus, increases the money supply in the economy. Conversely, selling securities results in a decrease in reserves, limiting the amount of funds that are available for lending. In effect, primary dealers are the Fed’s counterparties in open market operations (OMO).

Primary dealers, which all bid for government contacts competitively, purchase the majority of Treasury securities – Treasury bills, notes, and bonds – at auction and then redistribute or sell them to their clients, creating the initial market in the process. They are required to submit meaningful bids when new Treasury securities are auctioned. In a way, primary dealers can be said to be market makers for Treasuries. Accordingly, primary dealers trade Treasuries and typically also trade spread product.

In 2008, in response to the subprime mortgage crisis and to the collapse of Bear Stearns, the Federal Reserve set up the Primary Dealers Credit Facility (PDCF), through which primary dealers could borrow overnight at the Fed’s discount window using several forms of collateral including mortgage-backed loans. Federal Reserve Banks are authorized to accept loans and other bank obligations as collateral for advances at the discount window. The discount window is used by the Fed to rediscount private securities as a means to directly provide funding to banks at a particular interest rate and, thus, influence banks’ marginal cost of funds. The PDCF was closed on February 1, 2010.

A firm must meet the stipulated capital requirements before it can be considered a primary dealer. The capital requirements for broker-dealers that are not affiliated with a bank is $50 million. Banks acting as primary dealers need to have $1 billion of Tier 1 capital (equity capital and disclosed reserves). In addition, prospective primary dealers need to show they made markets consistently in Treasuries for at least a year before their application, and maintain at least a 0.25 per cent market share. Broker-dealers applying for a spot in the primary dealer system must register with the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA). Some of the well-known primary dealers in the United States include J.P. Morgan Securities LLC, Barclays Capital Inc., Citigroup Global Markets Inc., Wells Fargo Securities LLC, TD Securities (USA) LLC, Morgan Stanley & Co. LLC, Cantor Fitzgerald & Co. and Goldman, Sachs & Co.