As part of its long-planned effort to create comprehensive central counterparty capabilities that include guaranteeing the settlement of trades in the $300 billion-a-day mortgage-backed securities market, Fixed Income Clearing Corporation (FICC) today announced plans to develop new services that will underpin the proposed central counterparty.
Its goal, the corporation said, is to begin phasing in new services now so that it can have the full central counterparty capabilities up and running within two years.
FICC, which is a subsidiary of The Depository Trust & Clearing Corporation and last year cleared $75.6 trillion in mortgage-backed securities transactions, laid out its plans for building the new services today in a paper called "A Central Counterparty for Mortgage-Backed Securities: Paving the Way."
"When we get the central counterparty fully operational, we expect to lower clearing costs, reduce operational and counterparty risk, decrease our customers' capital charges and bring down the fail and financing expenses of our clearing members," said Tom Costa, managing director of DTCC Clearance and Settlement and head of FICC. "After several years of planning, extensive discussions with our customers and a thorough analysis of required systems capabilities, we're primed to get started," Costa said.
In trading mortgage-backed securities, financial institutions use the Electronic Pool Notification service operated by FICC's Mortgage-Backed Securities Division to allocate pools of mortgages to their trading positions. Because FICC does not function as a central counterparty for these trades, however, every obligation remaining after completion of the netting process must be allocated and then subsequently settled separately with each individual counterparty, which results in a series of disconnected processes.
In order to help the industry transition to a more efficient "straight-through" central counterparty model, FICC plans to phase in implementation of the services necessary to support the new central counterparty in three separate steps.
Phase I: In the first phase, FICC plans allow for the matching of specified pool trades via its real-time trade matching (RTTM) service. Scheduled for customer testing in the fourth quarter of 2006, "specified pool trade matching" will enable mortgage-backed securities trades to be submitted into FICC's real-time trade matching service for bilateral matching when both parties to the trade agree-at the time the trade is executed-exactly which pool number needs to be delivered on settlement date.
Phase II: The second phase FICC plans to implement involves simplifying and automating the routines for substituting the mortgages allocated to a pool. This step is scheduled for customer testing during the first quarter of 2007, with production roll-out to members during the second quarter.
Phase III: The next phase FICC will implement will allow for central counterparty netting-and guaranteed settlement-of specified pool trades, as well as pools allocated to a trade position. Tentatively scheduled for introduction by year-end 2007, this will eventually allow for full, multilateral pool netting and means that FICC will step in as a central counterparty to net pool obligations.
Costa noted that FICC has been in discussion with its customers who trade mortgage-backed securities since the publication of a white paper in 2003 that first broached the idea of creating a central counterparty. The creation of an industry working group in 2004 helped move the project along, he said.
The schedule to complete the project is ambitious, according to Susan Tysk, managing director for Product Management in DTCC's Clearance and Settlement Group. "We'll be working closely with market participants to review outstanding issues, to clarify business requirements critical to implementing the three phases, and to define new industry practices or processes that may need to be adopted," said Tysk.