The Mortgage-Backed Securities Division (MBSD) of Fixed Income Clearing Corporation (FICC) provides comprehensive netting and settlement services that address the unique needs of this specialized market.

Overview

The Mortgage-Backed Securities Division (MBSD) of Fixed Income Clearing Corporation (FICC) provides comprehensive netting and settlement services that address the unique needs of this specialized market. With the introduction of MBSD’s central counterparty (CCP) service for Pool Netting, the core netting and settlement services offered by MBSD will now include:

• Automated To-Be-Announced (TBA) and Specified Pool Trade (SPT) Trade Matching
• Multilateral Netting for TBAs
• Trade guarantee on fully matched TBA trades and SPTs
• Pool netting services that utilize FICC’s electronic communications channels

MBSD’s combined TBA trade and pool netting services reduce customers’ overall settlement obligations in two ways. First, MBSD nets eligible TBA trades, regardless of the identity of the trading party’s contra-side to establish net settlement obligations with both original and assigned counterparties. Subsequently, once pools have been allocated in satisfaction of these TBA settlement obligations, and the relevant details have been submitted into the Pool Netting system, the most active pools will be netted to decrease the associated securities deliveries. These two netting services, together with MBSD’s settlement guarantee for TBA trades and SP trades, free up capital and lower risk by:

• Greatly reducing the number of trades requiring actual settlement, and
• Netting and consequently reducing the number of pools required for delivery
• The results are lower operational costs and minimized fail risk from both a TBA and pool perspective.

Who Can Use this Service

MBSD Netting and Settlement Services are intended for MBS trading participants that meet FICC’s membership requirements, including brokers, dealers, banks, government securities issuers, mortgage originators, and investment companies.

Each MBSD applicant is required to execute an agreement binding it to MBSD’s rules and procedures. Applicants are evaluated on the following membership criteria:

• Capital adequacy
• Operational soundness
• Financial resources

Benefits

MBSD’s Netting and Settlement Services offer customers numerous significant advantages, including:

• A centralized process to compare, match and confirm TBA trades and SPTs in real time, reducing member execution risk
• A settlement guarantee at point of trade match
• A multilateral TBA netting facility to reduce the overall number of settlements associated with each member’s TBA trading activity, together with the pool netting service, resulting in substantial member savings as a result of fewer securities settlements
• A sophisticated accounting system to reconcile delivery variances resulting from netting obligations
• Streamlined processing resulting in significant reductions in members’ operating costs and the time and effort required to clear trades
• Critical risk management methodologies to reduce counterparty exposure and promote clearing and settlement safety

How the Service Works

Trade Matching and Comparison

All mortgage-backed securities trades entering the MBSD clearing and settlement systems must first be matched and compared using the Real-Time Trade Matching (RTTM®) service. Unless mortgage-backed securities trades are based on a specified pool, the trades are generally done on a “to-be-announced” (TBA) basis. As a result, the underlying deliverable securities are not known at the time of trade execution.

Trade details are therefore submitted to RTTM by both trading counterparties using generic TBA CUSIPs that identify the acceptable terms for the specific pools that will later be allocated to the trade.

The majority of trade details are submitted to RTTM using real-time interactive messaging. Submitted trades become binding obligations when RTTM reports comparison (matching) results to members, which could be within seconds of trade detail submission for members using interactive messaging. MBSD’s trade guarantee also takes effect immediately upon validation/comparison of the trade.

RTTM matches trades based on two-sided submission for trades executed between two direct trading parties, and three-sided submission for trades executed by an inter-dealer broker.

Securities Settlement

MBSD supports two settlement types: Settlement Balance Order (SBO) and Trade-for-Trade (TFTD). The SBO settlement system is MBSD’s trade netting system, which automatically pairs off settlement obligations with like terms, such as MBS product, coupon rate, maturity and settlement date, on a multilateral basis, i.e., regardless of contra party identity, resulting in the fewest possible number of receive/deliver obligations. Through the Trade-for-Trade settlement system, members are given the opportunity to settle individual trades on a gross basis, as originally executed, following matching and comparison of each trade.

SBO processing is available for all trade activity provided the following criteria are met:

The CUSIP of the MBS traded is eligible for SBO services

The contra-side accounts are SBO service-eligible The trade is executed in accordance with The Securities Industry and Financial Markets Association (SIFMA) TBA guidelines

The par value of the trade is at least $1,000,000, and is evenly divisible by $1,000,000

Trade-for-Trade services are available for all MBS products eligible for comparison services. Trade-for-Trade settlement may be used by members when a trade is not eligible for SBO processing or when the contra-sides to the trade agree that SBO processing is not desired. Specified pool trades, trades with stipulations inconsistent with TBA requirements, and trades executed to facilitate structured-product trading strategies are some examples of Trade-for-Trade activity.

MBSD performs the SBO process four times per month, corresponding to the four primary MBS settlement classes established by SIFMA. SBO netting commences at 2 p.m., 72 hours prior to the scheduled settlement date of the SIFMA class. MBSD SBO netting output is available to members by 2:00 p.m., thus providing members sufficient time to execute pool notification in accordance with SIFMA 48-hour notification requirements.

MBSD trade settlement requires the seller to allocate and assign specific pools, within SIFMA variance requirements, to specific TBA trades/obligations using the Electronic Pool Notification (EPN) system. This includes TBA obligations established via the TBA netting process as well as obligations resulting from the TFTD trades.

Pool Netting

Under MBSD’s CCP Pool Netting service, members will also submit pool details (in the form of “Pool Instructs”) into the pool netting system for bilateral matching versus their counterparties’ submissions. As many of the matched Pool Instructs as possible are then included in Pool Netting. For pools that meet all the criteria, FICC steps in as the central contra-party to settle the net pool obligations with members on a Delivery-versus-Payment (DVP) basis.

Pool Instructs that do not meet the selection criteria for inclusion in the Pool Netting service will continue to be settled directly between counterparties outside the clearing corporation. For these settlements, members will be required to submit Notifications of Settlement (NOS) to FICC to report the pool settlements to the clearing corporation so that the corresponding TBA obligations can be decremented and the associated margin released.

MBSD offers a variation of Trade-for-Trade services for members active in trading MBS options. Option contracts are compared through RTTM and, if exercised, result in either SBO or Trade- for-Trade settlement.

Customer Reports

To help participants manage their clearance activity, MBSD issues detailed electronic reports in both machine-readable output (MRO) and print image format. These include:

• Purchase and Sale Report: Serves as the sole legal and binding confirmation for compared trades, eliminating the need to exchange confirms and commitment letters, accelerating the confirmation process and reducing the possibility of errors and/or fails. The Purchase and Sale Report also is a 10b-10 compliant confirmation of trades.
• Uncompared Trade Report: Identifies trade terms that are inconsistent, serving as an early warning of potential trade breaks requiring resolution.
• SBO Summary: Identifies settlement obligations generated by the SBO netting process and provides a comprehensive audit trail of all multilateral and bilateral pair-offs created through SBO netting and eliminated for settlement purposes.
• Pool Instruct Activity Report: Reflects all activity that either establishes or targets a compared Pool Instruct for the current business day.
• Uncompared Report: Identifies the final disposition of all uncompared Pool Instructs that remain in an uncompared or advisory state on the current business day.
• Pool Netting Detail Report: Reflects Pool Instructs that have been included in the current business day’s netting cycle, as well as the net pool obligations established as a result of the pool netting process.
• Pool Obligation Activity Report: Reflects all pool settlement obligations established for the current business date that are to be settled versus FICC as CCP.

Automated Funds-Only Settlement

As part of the TBA Settlement Balance Order and Pool Netting processes, members can also incur cash obligations—or credits—primarily representing the difference between the average system prices used to calculate TBA and net pool obligations versus their respective contract and settlement values. Clearance differences and other cash adjustments such as miscellaneous fees, are also included in each member’s Funds-Only (cash-only) daily settlement.

For More Information

Please contact the Relationship Services Group hotline at (800) 422 0582, or send an inquiry via email to rmsupport@dtcc.com.