HKMA Exchange Fund Bills and Notes Market: Primary Dealer System and Obligations

The Hong Kong Monetary Authority (HKMA) is tightening its oversight of the Exchange Fund Bills and Notes (EFBN) market. In a circular issued in December 2024, the HKMA announced a revised Primary Dealer (PD) system, effective from 1 January 2025, introducing stricter performance obligations and a new tiered commission structure. This reform comes as the total outstanding amount of EFBNs reached approximately HKD 1.3 trillion as of November 2024, a record high driven by sustained demand for high-quality liquid assets. For any institution seeking to operate as a Primary Dealer in Hong Kong’s official reserves market, understanding these new obligations is no longer optional—it is a prerequisite for maintaining access to the primary issuance window. This article breaks down the regulatory framework, the revised obligations under the 2024 circular, and the practical compliance steps for PDs and aspirants.

The EFBN Market and the Primary Dealer System

The Exchange Fund Bills and Notes programme is the cornerstone of Hong Kong’s debt capital market. The HKMA issues these instruments on behalf of the Exchange Fund, and they serve as the benchmark risk-free yield curve for HKD-denominated securities.

Legal and Regulatory Framework

The EFBN programme is governed by the Exchange Fund Ordinance (Cap. 66). Section 3 of the Ordinance empowers the Financial Secretary to control the Exchange Fund, with the HKMA acting as the Fund’s day-to-day manager. The terms and conditions of each EFBN issuance are set out in the relevant Information Memorandum published by the HKMA.

The Primary Dealer system is established through a contractual framework, not a statutory code. The HKMA appoints PDs via a formal agreement, which incorporates the HKMA’s “Guidelines for Primary Dealers of Exchange Fund Bills and Notes” (the Guidelines). The most recent update to these Guidelines was announced in the HKMA’s circular dated 10 December 2024, “Revised Arrangements for Primary Dealers of Exchange Fund Bills and Notes” (the 2024 Circular).

Role of a Primary Dealer

A Primary Dealer is an institution appointed by the HKMA to act as a direct counterparty in primary auctions of EFBNs. The PD’s core functions are:

• Bidding at primary auctions: PDs must submit competitive bids for EFBNs at each auction.
• Market-making in the secondary market: PDs are required to provide two-way prices (bid and offer) for EFBNs to other market participants.
• Supporting market liquidity: PDs must maintain an orderly market, particularly during periods of stress.

The PD system is designed to ensure efficient price discovery and deep secondary market liquidity. The HKMA currently maintains a panel of approximately 15 to 20 PDs, comprising major international and local banks.

Benefits of Primary Dealer Status

Being a PD confers several commercial advantages:

• Exclusive access to primary issuance: Only PDs can bid directly in EFBN auctions. Non-PDs must purchase EFBNs in the secondary market.
• Commission income: The HKMA pays a commission on the face value of EFBNs allotted to the PD at auction. The 2024 Circular revised this commission structure.
• Enhanced market standing: PD status signals to clients and counterparties that the institution is a trusted liquidity provider in Hong Kong’s official market.

Key Obligations Under the Revised 2024 Circular

The 2024 Circular introduced several material changes to PD obligations. These changes took effect on 1 January 2025.

Step 1: Minimum Bidding Requirement

The most significant change is the introduction of a mandatory minimum bidding requirement. Under the previous system, PDs were expected to bid but had flexibility. The 2024 Circular now stipulates:

• Minimum bid ratio: Each PD must submit bids for at least 80% of the total amount of EFBNs offered at each auction across all tenors.
• Consequences of non-compliance: Failure to meet the 80% threshold for two consecutive auctions, or for four auctions within any rolling six-month period, will result in a written warning from the HKMA. Repeated non-compliance may lead to suspension or termination of PD status.

This requirement is designed to prevent “free-riding” by PDs who might only bid selectively on the most liquid tenors.

Step 2: Market-Making Obligations

The secondary market-making obligations have also been codified more explicitly. The 2024 Circular requires each PD to:

• Provide continuous two-way prices: During Hong Kong business hours, PDs must quote bid and offer prices for EFBNs across at least three benchmark tenors (e.g., 3-month, 6-month, and 1-year).
• Maximum spread: The bid-offer spread must not exceed 5 basis points for bills and 10 basis points for notes.
• Minimum quote size: Each quote must be for a minimum notional amount of HKD 50 million.

The HKMA will monitor compliance through its electronic trading platform, the Central Moneymarkets Unit (CMU) system.

Step 3: Reporting and Data Submission

PDs must submit detailed reports to the HKMA on a monthly basis. The 2024 Circular specifies the following data points:

• Volume of primary auction bids: The total face value of bids submitted and the allotment received.
• Secondary market turnover: The notional amount of EFBNs traded bilaterally and through the CMU.
• Quote statistics: The number of price requests received, the number of quotes provided, and the average bid-offer spread.

The HKMA uses this data to calculate a “Performance Score” for each PD, which directly determines the commission rate payable.

Step 4: Performance Score and Commission Structure

The 2024 Circular introduced a tiered commission system based on the Performance Score. The commission is paid on the face value of EFBNs allotted to the PD at auction.

Performance Score	Commission Rate (basis points per annum)
90 or above (Tier 1)	2.0 bps
70 to 89 (Tier 2)	1.5 bps
Below 70 (Tier 3)	1.0 bps

A PD that scores below 50 for two consecutive quarters will be subject to a review of its PD status. The Performance Score is calculated using a formula that weights bidding compliance (40%), market-making performance (40%), and reporting timeliness (20%).

Practical Implications for Aspiring and Existing PDs

The revised obligations create a higher barrier to entry and a more demanding operational environment for existing PDs.

Capital and Operational Readiness

To meet the minimum bidding requirement, a PD must have sufficient balance sheet capacity to take on EFBN inventory. The 80% bid ratio means that a PD must be prepared to bid for a significant portion of every auction, regardless of market conditions. This requires:

• Dedicated treasury desk: A team with expertise in HKD fixed income and the ability to price EFBNs across all tenors.
• Risk management framework: Limits for interest rate risk and inventory holding costs.
• Capital allocation: The institution must commit a minimum of HKD 500 million to HKD 1 billion in capital for EFBN market-making, depending on the scale of its PD commitment.

Compliance Infrastructure

The monthly reporting requirements demand a robust data capture and reporting system. PDs must:

• Automate trade capture: Link front-office trading systems to the back-office reporting engine.
• Implement real-time monitoring: Track bid ratios and quote provision continuously to avoid breaching the 80% threshold.
• Conduct internal audits: The HKMA may request an external audit of a PD’s compliance with the Guidelines.

Strategic Considerations for Non-PDs

Institutions that do not hold PD status can still access EFBNs through the secondary market. However, they face two disadvantages:

• No primary allocation: They must purchase from PDs, paying the bid-offer spread.
• Limited access during stress periods: In a market dislocation, PDs may widen spreads or reduce quote sizes, making it harder for non-PDs to trade.

For a bank or broker-dealer that aspires to become a PD, the application process involves submitting a detailed proposal to the HKMA’s Market Operations Division. The HKMA assesses the applicant’s financial strength, trading capability, and commitment to the market.

Enforcement and Consequences of Non-Compliance

The HKMA has a graduated enforcement framework for PDs that fail to meet their obligations.

Warning and Remediation

The first step is a written warning. The HKMA’s 2024 Circular states that a PD receiving a warning must submit a Remediation Plan within 10 business days. The plan must detail the steps the PD will take to restore compliance.

Suspension

If a PD fails to comply with its Remediation Plan, or if non-compliance persists for more than three months, the HKMA may suspend the PD’s bidding privileges for a period of 30 to 90 days. During suspension, the PD cannot participate in primary auctions and receives no commission.

Termination

The most severe sanction is termination of PD status. The HKMA may terminate a PD agreement with immediate effect if the PD:

• Fails to meet the minimum bidding requirement for six consecutive auctions.
• Provides false or misleading data in its monthly reports.
• Becomes insolvent or is subject to regulatory action that impairs its ability to perform its obligations.

A terminated PD cannot reapply for PD status for a period of 12 months.

Actionable Takeaways

1. Review your institution’s current EFBN bidding capacity against the 80% minimum bid ratio introduced by the 2024 Circular; a shortfall requires immediate capital reallocation or a reduction in PD commitment.
2. Implement automated compliance monitoring for the 5-basis-point maximum bid-offer spread on EFBN bills to avoid triggering a written warning from the HKMA.
3. Ensure your monthly reporting system captures all data points specified in the 2024 Circular, particularly the Performance Score components, as late or incomplete submissions directly reduce your commission rate.
4. Consider applying for PD status only if your institution can commit at least HKD 500 million in dedicated capital to EFBN market-making and maintain a dedicated HKD fixed-income desk.
5. Prepare a contingency Remediation Plan now, even if you are currently compliant, to address any future breach of the 80% bidding threshold within the HKMA’s 10-business-day deadline.

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