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. The core netting and settlement services offered by MBSD include:

• Multilateral Netting for To-Be-Announced (“TBA”) trades;
• Pool matching and netting services; and
• Settlement of pool obligations stemming from pool netting.

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, further netting occurs and net pool settlement obligations are settled by the members versus FICC as a central counterparty (CCP). These two netting services free up capital and lower risk by:

• Greatly reducing the number of trades requiring actual settlement;
• Netting and potentially reducing the number of pools required for delivery; and
• 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. In addition, the Capped Liquidity Facility (CCLF) ensures that FICC has enough liquidity in place in the event of a default of a major firm. 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 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; and
• Settlement versus FICC as a CCP for pool net settlement obligations stemming from pool netting.

How the Service Works

Settlement Balance Order Processing and Trade-for-Trade Transactions

MBSD supports the submission of two basic trade types: Settlement Balance Order Destined (SBOD) trades and Trade-for-Trade (TFTD) transactions. SBOD trades are “destined” for the TBA netting process on the scheduled netting day for their associated security class. TFTD transactions are submitting for matching within RTTM, but not for TBA netting.

For SBOD trades, the TBA netting service reduces the members’ overall TBA settlement obligations by netting trades having certain like trade terms across contrasides. This reduces the number of trades requiring allocation and settlement and ultimately lowers clearing costs. For TFTD transactions that are not netting, members are able to settle individual trades on a gross basis, as originally executed, following matching and comparison of each trade.

TBA Netting

MBSD performs the TBA Netting process four times per month, corresponding to each of 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 Settlement Balanced Order (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. SBOs established via TBA Netting as well as TBA TFTD trades must be allocated prior to settlement and the corresponding allocated pools are eligible for pool netting.

Trade Allocation

MBSD trade settlement requires the seller to allocate and assign specific pools, within Securities Industry Financial Markets Association (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. Through the allocation process, sellers tell buyers the pools they intend to settle in satisfaction of their TBA obligations.

Pool Comparison and Netting

Implemented as a pilot service in September 2009 and launched in April 2012, the MBSD CCP Pool Comparison and Netting service was designed to maximize overall savings by reducing the number of pool settlements. Members continue to allocate pools to their TBA obligations via EPN, but are also required to submit pool details (in the form of Pool Instructs) via RTTM® into the Pool Netting System for bilateral comparison versus their counterparty submissions.

Pool Netting gives members have the ability to net pools allocated to TBA obligations stemming from TBA Netting and TBA Trade-for-Trade (TFTD) activity to arrive at a single net position in a particular pool number. Although Pool Netting runs daily, the majority of pool netting activity follows the SIFMA calendar.

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, but are not limited to:

• Purchase and Sale Report: Serves as the sole legal and binding confirmation for compared TBA trades and Specified Pool 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.
• Open Commitment Report: This report lists all trades that remain open on the books of the clearing corporation, and indicates the trade’s disposition from the time it is matched, until it is fully settled.
• Pool Instruct Activity Report: Reflects all activity that either establishes or targets a compared Pool Instruct for the current business day. Pool Obligation Activity Report: Reflects all pool settlement obligations established for the current business date that are to be settled versus FICC as CCP.
• The MBSD CCP Pool Obligation Pending Settlement Report is produced each day at close of business to reflect all open net Pool Obligations (POIDs). This includes POIDs established via the current day’s Pool Netting cycle, as well as failed POIDs from previous netting cycles. This report provides a comprehensive listing of all the member’s open settlement obligations with FICC.

Securities Settlement

All obligations stemming from MBSD’s Pool Netting service settle versus FICC on a Delivery vs. Payment (DVP) basis over the Fedwire®. Members are notified of their obligations from Pool Netting the day prior to the scheduled Delivery Date. On Delivery Date, members are required to deliver securities to, or receive securities from, one of FICC’s designated accounts at its clearing banks in satisfaction of their net pool deliver or net pool receive obligations.

Automated Funds-Only Settlement

As part of the TBA Settlement Balance Order and Pool Netting processes, members can also incur cash obligations— debits 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 on FICC’s pool netting and settlement service, please click on this link to view the Source Book: http://www.dtcc.com/products/documentation/cs/ficc/mbs/sourcebook.pdf