DTCC Connection

Apr 02, 2012 • DTCC Connection

DTCC Launches New Central Counterparty for MBS Market

by Jim Conmy


Related Information

MBS CCP in the News

DTCC’s Fixed Income Clearing Corporation (FICC) subsidiary is launching its central counterparty (CCP) for mortgage backed securities on April 2, 2012. This groundbreaking initiative gives the securities industry a settlement methodology designed to reduce risk and costs in this $100-trillion-a-year market.


“This is the first CCP to be created in U.S. cash markets in more than a quarter of a century,” said DTCC’s President and Chief Executive Officer Donald F. Donahue. “We expect it will greatly reduce risk by offering pool netting services and streamlining the settlement of mortgage backed securities trades.”


The new CCP guarantees settlement of all matched mortgage backed security (MBS) trades, a crucial step for the industry, where the settlement of an MBS trade often does not take place until months after the trade itself is made. The FICC guaranty ensures completion of these long-settling trades even if one of the trading parties defaults on its initial trade commitment or pool delivery obligation.


Phased implementation

FICC is phasing in the CCP over a two-month period as pool delivery obligations to fulfill trades guaranteed beginning on April 2 are subsequently submitted for netting. The phase-in also allows member firms to adjust to new reporting and clearing fund requirements as well as same-day collection of settlement debits and credits.


The launch followed Securities and Exchange Commission approval of FICC’s plans on March 9.


Pool netting

Mortgage backed securities are made up of pools of mortgage loans that underlie each security. MBS trades are typically made on a “to be announced” or “TBA” basis, and FICC’s Mortgage Backed Securities Division (MBSD) had been netting most TBA trades shortly before settlement. Even before creation of the CCP, MBSD was able to net down more than 90% of the MBS trades it processed.


But in its role as a CCP for these trades, MBSD has introduced not only a trade guaranty but an additional netting process – pool netting – that further streamlines settlement on the related delivery obligations.


Delivery involves the allocation of specific pools to be delivered against these netted TBA obligations. Because pools are frequently allocated and reallocated against numerous TBA settlement obligations, these multiple redeliveries are operationally inefficient and potentially error-prone. By netting down offsetting allocations of pools against these delivery obligations, FICC’s new pool netting process is expected to reduce significantly the number of settlement deliveries and consequently help lower operational risk while easing settlement costs.


Margin modifications

With the introduction of a CCP, FICC has modified its clearing fund risk management process for MBS trades to account for two additional components: potential intraday exposure and the results of daily back testing. As a consequence, FICC anticipates that margin requirements for MBS trades could rise by 15% or more.


Prior to launching the CCP, FICC ran a long series of tests so that its 70-plus trading members could review the impact the new margin components might have on their daily clearing fund requirements.


An innovation that lowers risk

“Having a central counterparty for MBS trades is an innovation that will lower systemic and operational risk in the U.S. MBS market,” said Murray Pozmanter, DTCC Managing Director and General Manager, Clearing Services. “We’ve been working for a number of years to bring a trade guaranty to this market segment, and I’m confident this marks a substantial improvement in how the market can function.”


FICC offers services to market partici-pants trading agency pass-through mortgage backed securities issued by the Government National Mortgage Association (GNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA), more commonly known as Ginnie Mae, Freddie Mac and Fannie Mae. These MBS make up the bulk of the U.S. mortgage market. @


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