The Depository Trust & Clearing Corp. (DTCC) said that the Securities and Exchange Commission has approved its application to operate a new central counterparty (CCP) to limit MBS-related risk and costs.
Starting in April, the MBS Division (MBSD) of DTCC’s Fixed Income Clearing Corp. (FICC) unit will begin functioning as the CCP for MBS trades.
It will guarantee settlement of all matched MBS trades, which is key for the securities industry where an MBS trade settlement usually does not take place until months after the trade happened. The FICC guaranty will ensure the completion of these long-settling trades even if one of the trading parties defaults on its initial trade commitment or pool delivery obligation.
“This is the first CCP to be created in U.S. cash markets in more than a quarter of a century. We expect it will greatly reduce risk by offering pool netting services and streamlining the settlement of mortgage-backed securities trades,” said DTCC’s President and Chief Executive Officer Donald Donahue.
FICC’s MBSD is now able to net down over 90% of the MBS trades it processes, although in its role as a CCP for these trades, it will introduce not only a trade guaranty but an added netting process that will further streamline settlement on the related delivery obligations.
MBS comprise pools of mortgage loans that underlie each security. MBS trades are usually effected on a TBA, and MBSD now nets most TBA trades shortly before settlement. 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, the many redeliveries are operationally inefficient and can be prone to error. By netting down offsetting allocations of pools against these delivery obligations, FICC’s new pool netting process will considerably lessen the number of settlement deliveries and thus help lower operational risk while easing settlement costs.
FICC, which has conducted testing of the CCP for some time with a number of its member firms, plans to launch the CCP formally for all members on April 2.
The phase-in period will extend over two months as pool delivery obligations to fulfill trades guaranteed starting on April 2 are subsequently submitted for netting. The phase-in will also give member firms time to adjust to new reporting and clearing fund requirements as well as same-day collection of settlement debits and credits.
FICC offers services to market participants trading agency pass-through mortgage-backed securities issued by Ginnie Mae, Freddie Mac and Fannie Mac. The FICC already offers CCP services to the market for U.S. Government securities trades.
“Having a central counterparty for MBS trades is a real 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.