The Mortgage-Backed Securities Clearing Corporation (MBSCC), the sole provider of automated post-trade comparison, netting, risk management and pool notification services to the MBS market, has issued a risk management white paper with proposals that could have a significant impact on the future process of MBS trading.

Among several important changes made to its risk management practices, the current white paper, now circulating among the company's constituents for comments, contains a proposal that would totally re-engineer the process of netting for MBS trades.

Typically, there are two distinct processes for netting: one is called "balance order," whereby a clearing corporation links buyers and sellers for settlement, but is uninvolved otherwise. The other method is called "novation," whereby the clearing corporation becomes a central counterparty to all settlements. While MBSCC does not novate and is not contra-side to settlement, it is now proposing to inaugurate settlement by novation.

"Parties would now look to MBSCC instead of to each other," said Lynn Douglas, COO of MBSCC. "This is an alternative way of looking at things. This would allow our members to maximize balance-sheet relief and ensure settlement will occur through the original counterparty, even if it is not in business anymore. This would add certainty to the process and reduce margin requirements."

The Bond Market Association prompted this re-thinking for MBSCC last year when it reduced the variance of delivery for MBS from 1% to .01%, an amount that was no longer significant.

"This made us take a fresh look at our business and the services we provide," Douglas said. "With the new method, the MBSCC would become counterparty to all net pool settlements, as opposed to our members individually doing all of this."

The proposal is still in its formative stages, Douglas said, and will be fleshed out further in a follow-up white paper, due out at the end of October. There are still many challenges to overcome, she said, because the to-be-announced (TBA) nature of the MBS market and the need to settle independent pools in satisfaction of a TBA trade creates a wide variable for definition.

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