by James Conmy
Every morning for nearly two months now, securities firms, banks and other participants in the mortgage-backed securities (MBS) market have been able to see the difference in how their MBS trades are currently margined versus how the margining process would work under a central counterparty (CCP).
This “parallel testing” period has allowed trading firms to compare the current clearing process and its margin requirements with what would take place under a CCP with pool netting. It is one of the steps DTCC’s Fixed Income Clearing Corporation (FICC) is taking to help its members prepare for the anticipated launch later this year of the new MBS CCP, subject to approval by the Securities and Exchange Commission.
Although FICC already nets the to-be-announced (TBA) trades that come into the company for clearing, it has never netted the pools of mortgages that underlie the trades and are sent to FICC prior to settlement. With the start of its CCP operation, however, FICC will guarantee trades upon TBA matching and then begin its new Pool Netting Service, which will net the most active pools.
In its role as a central counterparty, FICC will then become the contra-side to any net pool settlement obligations that result from the pool netting process. Obligations that cannot be pool netted will be left to firms to settle directly with their opposite trading party, just as they do today.
To prepare for the CCP process, FICC is instituting some operational changes, such as same-day notification of settlement and same-day processing of debit and credit cash differences resulting from settlement balance order (SBO) netting.
Two Clearing Fund additions
When the CCP goes live, FICC will also require two new margin components from its member firms to meet their Clearing Fund requirements.
One addition, called the Coverage Component, involves a daily “back test” to ensure that each member firm has enough collateral on hand for that day to meet the assumptions calculated by FICC’s “Value at Risk,” or VaR, model. The model assumes that if FICC has to liquidate a member’s portfolio, it can do so in three days, and that the Clearing Fund – based on VaR calculations – will be able to cover a loss on the member’s portfolio due to price movements during the liquidation period at least 99% of the time.
“The Coverage Component looks back at the historical calculation to see if it accurately covered these potential losses based on the mark-to-market price movement in the portfolio,” said Caithlin Corrigan, DTCC director, Enterprise Risk Management. “If the coverage was less than expected, then the Clearing Fund requirement is adjusted accordingly.”
The other Clearing Fund change FICC plans for CCP operation is designed to deal with potential intraday exposure. Named the Margin Requirement Differential, it provides a snapshot of the intraday risks in a portfolio versus its end-of-day status. Firms whose “differential” is large will typically have to post more intraday margin.
Updated test results
FICC member firms that participated in the parallel testing period that ran from December 2011 through January 2012 now have a better understanding of what this part of their Clearing Fund requirements will amount to, because they were able to compare their current collateral needs with what will be expected under the CCP, according to Michele Hillery, DTCC vice president, Clearance and Settlement, Fixed Income Clearing Corporation.
“This is like taking a test drive before a race,” she said. “Then, when you get on the track, you have an idea what to expect.” @