NatWest Markets dropped out of a handful of primary dealerships last week, but, for better or for worse, the business model shows scant signs of changing.
They will not say it publicly, but when speaking off the record bankers are swift to turn vociferous in their denunciations of primary dealerships. Many on both sides of the fence say "they don't make sense". Those who have given up the game give a scornful laugh, while those still in it resentfully list the many services they offer to DMOs for little to no compensation, before recalling the list of reasons they can't simply withdraw.
The problem is not universal. Some primary dealerships have a balance of auctions and fee paying syndications that banks seem happy with. Other sovereigns — like Italy — have found different ways of compensating their dealers to keep them happy.
But some — and it tends to be the biggest ones — are happy to maintain an arrangement designed to extract the maximum possible value from banks with the minimum possible compensation. Given that they are spending taxpayers’ money, who can blame them?
Accordingly, banks like NatWest are doing the sums, coming up with answers they don’t like, and deciding they’d rather put their resources elsewhere. The EU, for example, has a lot of syndications lined up. Its auctions may well seem like a better use of bankers’ time and balance sheets.
But the fact is that even if the syndication fees are not enough to compensate banks for the work they do as primary dealers, the PD badge is still important for those who want to maintain a footprint in a particular jurisdiction. They need to ensure they can serve clients with natural demand for the auctioned bonds, and they need to keep a close eye on the government bond market to ensure the best service for their corporate clients in the country.
That means banks with regional focuses have the most to gain from primary dealerships, while global banks have to be absolutely on their game if they are to ensure that the synergies they can extract from primary dealerships leave them better off than pulling out. Sometimes, that simply won’t be possible.
A few drop outs like NatWest are not going to change the minds of DMOs on the topic — especially with giants like Deutsche Bank returning to prominence in the SSA market.
Yes, DMOs could pump up demand at auctions by sweetening the deal for their dealer networks. That would mean a livelier and more dynamic market with hot auctions.
But DMOs don’t care about hot auctions. The only thing that will persuade them to change their minds is if so many banks pull out or reduce the size of their bids that auctions actually fail. If that happens, then the curves will cheapen and DMOs will have to take action.
Until then, the banks will continue to eat the losses.