Here's how the central counterparty (CCP) for mortgage-backed securities will deliver a double-netting capability, first netting "to-be-announced" (TBA) trades and then their underlying pools, providing guaranteed settlement in the process.

Step 1: trade netting

FICC has long netted mortgage-backed securities trades in order to reduce the number of transactions requiring financial settlement. Typically, FICC eliminates around 95% of the trades' par value through netting. As a result, its customers have had to allocate many fewer pools of the mortgages that underlie the securities because the trades have been eliminated by netting. Meanwhile the capital that was tied up in the trades is freed up for other uses.

But unlike equities, for example, which are backed by the financial performance of the companies that issue them, mortgage-backed securities are backed by other financial instruments - pools of mortgages. For these trades to settle, the sellers have to satisfy their TBA obligations, which means what they really have to deliver are the underlying mortgage pools.

What makes the process even more complicated is that typically sellers don't decide just which pools they will settle for their trades until a few days before settlement. That's why the trades are known as to-be-announced.

Step 2: pool netting

To streamline the processing of mortgage-backed securities trades, FICC will now perform a second netting process. After netting the trades, then it will net the underlying pools of mortgages, because they are what have to be delivered in order to satisfy the trade obligation.

This second netting step eliminates many of the pools underlying the mort-gage trades by offsetting the various pools that a seller is obligated to deliver against the pools that other traders are required to deliver. Just like trade netting, pool netting eliminates a great many of the deliveries that would otherwise have to be made. At this point, the trades are finally ready for settlement. When the sellers deliver the required pools, the trade obligations are met.

"We sometimes call this ‘the finer sieve process'," said Dennis Paganucci, DTCC director, Clearance and Settlement Product Management. "First we put the trades through one sieve to net them. Then, we use a finer sieve to net the components of the traded securities - the mortgage pools that underlie them. That's why it's a two-step process." @