The institution of the system of satellite dealers is another logical move in the series of steps taken by the Reserve Bank of India (RBI) towards developing the market for government securities. The satellite dealers are expected to complement the functioning of the primary dealers (PDs), on a smaller scale. On the retail front, the primary dealers have been hampered by the fact that they do not have a distribution network of their own, although some, like SBI Gilts are working out the modalities of taking advantage of the State Bank of India branch network, initially in the metros. Non bank finance companies (NBFCs), who are expected to apply for membership as satellite dealers should be able to complement the operations of PDs, given the fact that they have a time tested distribution and broker network. All this should, in turn, help in creating a retail segment.
The geographical reach of the applicants for satellite dealership will be a criterion uppermost on the mind of the RBI when it vets their applications. With the exception of PNB Gilts, the operations of the primary dealers are concentrated in Mumbai. Among the primary dealers, both the Discount Finance House of India (DFHI) as well as Securities Trading Corporation of India (STCI) have concentrated on the wholesale segment.
The other players i.e. ICICI Securities and Finance Company Limited, SBI Gilts Limited, PNB Gilts Limited and Gilt Securities Trading Corporation Limited are exploring ways and means for tapping the retail investors.
SBI Gilts appears to be the first one off the block. It has identified the branches of State Bank of India in the metro cities through which it would tap the retail investor.The alternative to using the branch network of the banks would be for the primary dealers to get into marketing agreements with the satellite dealers. This would help both the primary dealers as well as the satellite dealers in meeting their turnover commitments.
Initially, the satellite dealers are expected to duplicate the work done by the primary dealers. They too will be tapping the wholesale segment i.e. companies and provident funds. They are also expected to execute back to back deals, i.e. source an order and then buy corresponding the securities from the auctions or the secondary market.
Working out strategies
Consider for instance the strategy to be adopted by Ceat Financial Services Ltd, an aspiring satellite dealer. The company plans to operate in the gilts market at three levels. Firstly, it will be trading on own account. Ceat Financials being an NBFC has to park a portion of its funds in government securities because of the SLR prescription of 15 per cent. The satellite dealer segment of the company will churn this portfolio around with a view to increasing the returns. Secondly, the company plans to cater to the requirements of the 40 odd companies in the RPG group. These companies are expected to source their requirements of government paper from Ceat Financials. Thirdly, in its capacity as a market maker the company intends to offer two way quotes in the market on a continuous basis.
For that matter, the money market division of Ceat Financials has already begun operations as a market maker three months ago. To ensure that it does not chew more than it can bite, it has put an upper limit of Rs 10 lakhs while offering the quotes. Lastly, it plans to use its 20 odd branches spread over the country with a view to tapping high net worth individuals and retailing the securities.
In general, NBFCs are not expected to promote a separate company for the satellite dealership business. For an entity solely in the business of gilts market, to post a return of 16 per cent it will have to achieve an outright turnover of Rs 500 crore during a year, says an official with
Ceat Financials. However, the RBIs guideline stipulate that satellite dealers need to achieve an outright turnover of only Rs 30 crore. Achieving this turnover should not however be a problem.
Graded targets
The strategy followed by the RBI is very clear. In the first year of operations, the RBI intends to set targets which the market makers can achieve comfortably. For instance, when the operating guidelines for the primary dealers were announced, the RBI was very lenient on the targets it set for them. All the primary dealers have met their commitments that they made to the RBI. Even on the devolvement front, the six primary dealers together have to pick up only around 15 per cent of the devolved amount. It is expected that the targets set for the primary dealers for the forthcoming financial year will be more demanding.
The satellite dealers are expected to have a minimum net owned funds of Rs 5 crore.
We had expected this figure to be higher at around Rs 20 crores, says a primary dealer. If the satellite dealer leverages upto 5 times, then he can hold securities worth Rs 25 crore. This, by itself, is not a significant sum to be making a difference in the market. But then the size of the deals executed by the satellite could be anywhere in the region of Rs. 5 - 50 lakhs. Initially, the satellite dealers are expected to execute back to back deals and not take positions. If that be the case, then the stipulated figure of Rs 5 crore is enough, and they can rely on the call money market for funds their operations. Only if the entity plans to take a position and be an active trader in the market will it have to bring in more capital into the business.
The possible reason behind the move to keep the minimum net owned funds at a low figure could be to attract a wide range of participants. In addition to the NBFCs, the brokers in the debt market segment of the National Stock Exchange could be interested in empanelling themselves. It is generally felt that if the RBI manages to empanel around 15 satellite dealers, then it would have made a decent beginning.
The principal source of funding for these entities will be the call money market. But then their ability to borrow will be constrained by the counter party limits that the banks will be offering them, says N.Gopalakrishnan, managing director SBI Gilts. Given that these entities are promoted by NBFCs, the banks would be hesitant in giving a sizeable limit to them. This could constrain the market- making functions of these entities.
The fear that the NBFCs could fund their other operations by borrowing from call is misplaced. The reason for this is the stipulation that their net outstanding borrowing from the call market cannot be more than the value of their holding of government securities. It has also been stipulated that 20 per cent of their assets needs to be in the form of government paper.
On the liquidity front, the RBI has recommended to the government of India that the satellite dealers should be allowed repo facilities. However, unlike primary dealers, the satellite dealers are not eligible for commissions on the successful bids that they put in the auctions. Nor are they eligible for refinance facilities from the RBI. The reason for this is that the satellite dealers are not required to make any firm commitments at the auctions nor are they required to pick up develovements in any issue.
Not on par
The non availability of commissions could however prove to be a problem in case of the satellite dealers. The favourable market conditions during the current financial year has helped the operations of the primary dealers. Contrary to the initial scepticism, the primary dealers have managed to post handsome profits in the first four months of their operations. However, more than 60 per cent of the profits that they have made is on account of the commissions given by the RBI. While the remaining portion might have come on account of trading on their portfolio, their ability to churn the portfolio is due to the commissions. While the practice of sharing the commissions in an open manner has been put to an end, they now get reflected in the price of the securities after the auctions.
In due course, once the operations of satellite dealers stabilise, they could be asked to make firm commitments against which they could be given commissions and refinance facilities. This would provide a fillip to their efforts at market making.
Contrary to expectations, the RBI has not made it mandatory for a satellite dealer to tie up exclusively with a primary dealer. The market makers are expected to take their own decision in this regard. One option could be to tie up with a primary dealer. While the satellite dealer could give firm commitments to the latter, in turn, the primary dealer can extend lines of credit or share commissions with the former.
Whether these entities succeed in their efforts at retailing, would depend on their ability to create an awareness about the investment opportunities in gilts. Most of the trusts and the smaller provident funds prefer to hold securities in physical form. The other deterrent could be the usual time lag of over two weeks before the physical securities can be delivered. This is where the RBI should step in and streamline the settlement systems.
