The Depository Trust & Clearing Corporation (DTCC) announced today that the Securities and Exchange Commission has approved its application to operate a new central counterparty (CCP) designed to reduce risk and costs in the $100-trillion-a-year market for U.S. mortgage-backed securities (MBS).
Starting in April, the Mortgage-Backed Securities Division of DTCC's Fixed Income Clearing Corporation (FICC) subsidiary will begin functioning as the CCP for MBS trades. It will guarantee settlement of all matched MBS trades, a crucial step for the securities industry where the settlement of an MBS trade often does not take place until months after the trade itself was made. The FICC guaranty will ensure completion of these long-settling trades even if one of the trading parties defaults on its initial trade commitment or pool delivery obligations.
"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 F. Donahue.
FICC's MBS Division is currently able to net down more than 90 percent of the MBS trades it processes, but in its role as a CCP for these trades it will introduce not only a trade guaranty but an additional netting process—pool netting—that will further streamline settlement on the related delivery obligations.
Mortgage-backed securities are composed of pools of mortgage loans that underlie each security. MBS trades are typically effected on a "to be announced" or "TBA" process, and MBSD currently 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, 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 will significantly reduce the number of settlement deliveries and consequently 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 beginning on April 2 are subsequently submitted for netting. The phase-in will also allow member firms 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 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. FICC already provides 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.