Skip to main content

by Jim Conmy

In the first month of operating its new central counterparty (CCP) for mortgage backed securities (MBS) trades, DTCC achieved a 67% reduction in the volume of mortgage pools and payments involved in settling the trades. This decrease translates into a significant reduction in the costs and operational risks for clients active in this market.

“The cost of delivering a mortgage pool can run to $15 per pool,” said Michele Hillery, DTCC Vice President, Fixed Income Product Management. “Fewer deliveries mean lower operational risk and lower settlement costs – and those are the goals we set out to achieve.”

The new CCP began processing trades April 2, 2012, after several years of testing and regulatory approval procedures. It is managed by DTCC’s Fixed Income Clearing Corporation subsidiary.

Two-step netting

In the first cycle of “Class A” trades to go through the CCP, DTCC netted the nearly 43,000 pool allocations underlying the trades down to less than 13,000. As the month progressed, the processing of “Class B and C” MBS trades through the CCP also brought significant reductions in the number of securities and payments that had to be delivered to complete the transactions, thus eliminating the movement of billions of dollars’ worth of cash and securities.

The new CCP achieves its results through a kind of double-netting process. In the first step, it netted down more than 90% of the trades submitted for processing. Then, in a second step, it netted down the underlying pools of mortgage securities and cash payments that have to be exchanged to complete the trades still remaining. For “Class A” trades, the reduction was 70%. Later in the month, the CCP was able to follow its pool netting success with “Class A” securities by netting down pool delivery instructions for “Class C” MBS trades from about 37,500 to 11,500, a 69% reduction.

“These results mark an important gain for the industry,” noted Murray Pozmanter, DTCC Managing Director and General Manager, Clearing Services. “Our clients were surprised at how swiftly the pool netting process was completed and delighted by how much it reduced their obligations to exchange funds and securities.”

First-ever guaranty

The CCP provides the first-ever guaranty that matched MBS trades will be completed even if one side to the trade defaults or fails to deliver the pools of mortgage securities that underlie the trade. Because the settlement of an MBS trade often does not take place until months after the trade itself, the trade guaranty is a long-sought step for the securities industry.

The first CCP created for U.S. cash markets in more than 25 years, it streamlines the complex delivery process involved in completing MBS trades. Delivery entails the allocation of specific pools to be delivered against the netted “To-Be-Announced” (TBA) obligations. Because pools are frequently allocated and reallocated against numerous TBA settlement obligations, there can be multiple redeliveries, creating a process that’s operationally inefficient and potentially risk-prone. The new CCP process allows DTCC to net down offsetting allocations of pools against these delivery obligations, which can sharply reduce the number of settlement deliveries.

Phasing in

The MBS CCP services have been phased in from April through May so that FICC’s member firms can adjust to new reporting and clearing fund requirements as well as same-day collection of settlement debits and credits. By July, all the securities classes to be settled will have gone through the CCP and member firms will have experience with them.

DTCC offers this CCP service to market participants trading agency pass-through mortgage-backed securities issued by the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, more commonly known as Ginnie Mae, Freddie Mac and Fannie Mae. Securities from these government-sponsored enterprises make up the bulk of the U.S. mortgage market. @