Central Counterparty Pool Netting Service for Mortgage-Backed Securities: MBS CCP Pool Netting

Transcription

1 Central Counterparty Pool Netting Service for Mortgage-Backed Securities: MBS CCP Pool Netting June 8, 2007 Introduction Service Overview As part of our ongoing efforts to provide key services for mortgage-backed securities (MBS), the Fixed Income Clearing Corporation (FICC), a subsidiary of The Depository Trust & Clearing Corporation (DTCC), is releasing this New Service Bulletin announcing its plans to implement an MBS CCP Pool Netting service, with initial participant testing scheduled for Q The MBS CCP Pool Netting service is being designed with extensive input from the MBSD membership to maximize overall savings by reducing the number of pool settlements (and the associated risks and costs), while simultaneously minimizing members development efforts. To that end, the service was structured so that the most actively traded pools would be netted and settled versus FICC as CCP, while less active pools would continue to settle as they do today, i.e. directly between members. This provides a best of all possible worlds solution that specifically targets pools that most benefit from the Pool Netting service, while avoiding the imposition of additional settlement costs for thinly traded pools. Under the new service, members will continue to submit their TBA activity to the Real-Time Trade Matching (RTTM) system to bilaterally match their trade data with the corresponding trade data submitted by their counterparties. (In addition, members will have the ability to submit their Specified Pool Trades by the time the Pool Netting service is implemented.) In conjunction with the implementation of Pool Netting services, FICC will also provide its settlement guaranty for all TBA and Specified Pool Trades at the point they are matched within FICC s Real-Time Trade Matching (RTTM) system. After TBA Netting is run, sellers will continue to use the Electronic Pool Notification system (EPN) to allocate pools in satisfaction of their TBA Trade-for-Trade (TFTD) and Settlement Balance Order (SBO) obligations. In addition to sellers submitting allocation data to EPN as they do currently, both buyers and sellers will also submit pool netting input to RTTM Pool Netting. If the pool input submitted by buyers and sellers match in RTTM, and a corresponding open TBA net obligation with the same trade terms is identified, the pool data will be applied to the TBA position and the remaining outstanding position will be reduced accordingly. Pool input will not be eligible for Pool Netting if it cannot be associated with an open TBA position (even if it is matched between buyers and sellers). On the evening of Delivery Date minus one, FICC will analyze each clearing member s pool activity to determine which pools would receive the maximum benefit from CCP Pool Netting, based on their trading velocity and projected netting factor. In addition, FICC will identify pools with like terms that can be paired-off on a multilateral basis. These will also be settled versus FICC as CCP. A smart delivery algorithm will be employed to minimize the number of deliveries members must make to satisfy their pool obligations, and to reduce associated costs and operational risks. FICC will automatically close out outstanding settlement obligations and release corresponding margin as settlement is effected between FICC and members.

2 As previously noted, all other pools will continue to settle as they do today, i.e., directly between original or assigned TBA counterparties as determined by their TBA activity. For settlements that occur outside the clearing corporation, members will continue to be required to submit Notifications of Settlement (NOS) to close out their outstanding settlement obligations and receive their corresponding margin return. Pool Netting Part of Multi-Phased Plans for CCP Services FICC outlined its plans to provide CCP services for MBS in its white paper entitled A Central Counterparty for Mortgage-Backed Securities: Paving the Way issued in April That paper described plans for the phased introduction of three important new services to the MBS marketplace RTTM Specified Pool Trade Matching, EPN Pool Substitution and CCP Pool Netting with Guaranteed Settlement. For the past year, FICC has been working diligently to develop these new services and bring them to the market in accordance with the aggressive timetable set forth in the paper. We have been successful in meeting our milestones to provide these services within the published timeframes. For RTTM Specified Pool Trade Matching, a New Service Description was published in Q2 2006, followed by Interactive Messaging Specifications in Q Participant testing is currently under way, and implementation is slated for June 22, A New Service Description and EPN Messaging Specifications were issued concurrently in early Q for the EPN Pool Substitution service. Participant testing has begun, and implementation of this service is slated to occur in Q3. The issuance of the New Service Description for CCP Pool Netting evidences the great strides that have been made over the past year, as FICC worked in tandem with the MBS CCP Steering Committee and individual MBS members to develop a rollout strategy for CCP Pool Netting and related services to achieve the following key benefits: Fewer number of securities movements required to settle MBS obligations; Guaranteed settlement; Earlier problem detection; Expedited return of margin collateral; Reduced fails; No processing changes for pools that do not meet Pool Netting eligibility criteria; and Foundation for future MBS CCP enhancements. FICC has established the following timeline providing dates when key deliverables will be completed for MBS CCP Pool Netting. CCP Pool Netting Detailed Service Description Q Interactive Messaging Specifications Q Participant Testing Q Implementation Q

3 Implementation will, however, be contingent upon receiving SEC approval of the requisite Rule filing for providing these new services. This paper describes the major tenets of the proposed CCP Pool Netting service. As always, FICC staff will be available to answer your questions and provide general support to members as you begin planning your development for CCP Pool Netting implementation. Contact information is provided at the end of this paper. TBA Processing The new CCP Pool Netting service will not change how existing TBA-associated processes are performed. FICC will, however, provide its settlement guaranty to all TBA trades upon matching. The current TBA processes that will remain in place include: TBA trades and Specified Pool Trades (SPTs) should be submitted and matched via the Real-Time Trade Matching (RTTM) service; Settlement Balance Order (SBO) and Trade-for-Trade (TFTD) trade types will continue to be supported as they are today; All trade reconciliation actions will continue to be supported (such as Dealer Affirms, DKs, Cancels of Uncompared, Modifies) All existing reports will continue to be generated to support trade processing (e.g., RTTM Uncompared Reports, Purchase and Sale Reports, Open Commitment Reports, etc.); TBA Netting will occur on 72 Hour Day using the existing Settlement Balance Order (SBO) model; Sellers should allocate pools to their TBA obligations via EPN beginning on 48 Hour Day versus the assigned counterparty; To confer additional benefits to members, FICC will seek to push back the current TBA netting timeframe until later in the day to maximize the number of matched TBA trades included in the TBA net. This would, in turn, reduce the outstanding TBA obligations requiring allocation and settlement. Specified Pool Trade (SPT) Processing While FICC will also extend its settlement guaranty to SPTs upon matching, SPTs will not be eligible for CCP Pool Netting, since members have indicated a desire to effect delivery of SPTs as traded (i.e., members designate the pools they want to settle on input for SPTs). Pool Input, Verification, Matching and Available TBA Position Check In addition to allocating pools to TBA obligations via EPN, members will also be required to submit pool netting input into the RTTM Pool Netting system. Members will have two mechanisms for submitting pool data to FICC for bilateral Pool Matching and subsequent Pool Netting: ISO-based Messaging (Interactive, batch or multibatch) and RTTM Web. Proprietary batch input will not be supported. Bilateral matching is a prerequisite for Pool Netting, and will occur in real-time upon receipt of input. In order for matching to be effected, the mandatory match pool data submitted by the seller must be the same as the mandatory match pool data submitted by the buyer. Upon matching, the system will verify that the pool netting input is associated with a valid TBA obligation that has sufficient available position. All matched pools for which sufficient open TBA position exists will pend in Pool Netting. If sufficient TBA position does not exist for 3

4 matched pool input (i.e., the TBA has been over allocated), it will be rejected prior to the execution of Pool Netting. Pools pending Pool Netting at the established Pool Netting cutoff will become part of the selection criteria used to determine which pools will be netted and settled versus FICC as CCP. CCP Pool Netting and Settlement The central objective of CCP Pool Netting and Settlement is to reduce the number of pool settlements a member must make, thereby lowering associated settlement costs and operational risk. To that end, FICC will employ two Pool Netting methods: 1) Single Net Position Netting; and 2) Pair-Off Netting. The associated pool obligations stemming from either of the Pool Netting methods will settle versus FICC as CCP. All other pools will be settled as allocated with the original settlement counterparty at the original price, thus eliminating unnecessary delivery sides and associated clearing bank charges. Note that CCP Pool Netting will be performed on a daily basis to accommodate settlements associated with late allocations and substitutions where the delivery date for an obligation is changed. Single Net Position Netting On the evening of Delivery Date minus one, FICC will run an algorithm to determine netting-eligible pools based on certain selection criteria. These are: 1) pool trading velocity (to identify the most active pools); and 2) pool netting factor potential (to determine pools that, when netted, will yield the best netting factors). To do this, FICC will set configurable parameters for setting trading velocity criterion (minimum pool current face) and netting factor criterion (minimum acceptable netting percentage) that pools must meet in order to be included in Pool Netting. Because these parameters are configurable, and because trading patterns are dynamic, nettingeligible pools could change from day to day. Once netting-eligible pools are defined, Single Net Position netting will be employed for qualifying pools. For each member, eligible pools associated with both TBA TFTD and net TBA SBO activity will be netted into a single net position per pool number. At that time, the TBA trades will be terminated and replaced with the resultant receive or deliver obligations, which will be novated for settlement versus FICC as CCP. (Note: Once TBA trades are terminated, they are no longer available for subsequent action.) Pool Pair-Off Netting To further increase the number of settlements that can be effected versus FICC as CCP, FICC will employ Pair- Off Netting for pools that are not eligible for Single Net Position Netting. Pair-Off Netting will pair-off pool input that has the same current face, contractual settlement date and delivery date. FICC will pair-off a member's buys and sells on a multilateral basis across all of its counterparties (i.e., it will pair-off buys and sells done with the same contra, as well as buys and sells done with different contras). For example, member A s sell of 1MM to member B would pair off against member A s buy of 1MM from member C, provided the current, contractual settlement date and delivery date were the same. The resultant obligations (member B s delivery to member C) would settle versus FICC as CCP. Cash differences associated with paired-off transactions would be settled as part of Funds Settlement. Two Settlement Paths: 1) Versus FICC as CCP for Netted Pools and 2) Directly Between Original Allocation Counterparties for Unmatched Pools and Pools Not Eligible for Netting All settlement obligations stemming from CCP Pool Netting (whether Single Net Position Netting or Pool Pair- Off Netting) will be satisfied by clearing members by delivering securities to, or receiving securities from, FICC at the clearing bank designated by FICC. Clearing members will be obligated to properly instruct their clearing 4

5 bank as to the movements to be made to and from FICC. All settlement obligations will be settled versus payment over the Fedwire at the FICC-assigned, uniform settlement value. The difference between the original contract settlement amounts of pools comprising the net settlement obligation and the uniform value at which the net obligation is settled will be debited or credited to clearing members as a Transaction Adjustment Payment ( TAP ) as part of the clearing members Funds-Only settlement requirement. For settlements conducted versus FICC as CCP, associated mark and margin for settled pool obligations will be released on settlement date plus one. As noted previously, pool settlements that are not eligible for CCP Pool Netting (either because they don t meet the selection criteria for Pool Netting, or because the pool submitted to Pool Netting remained unmatched at the cutoff time for the service) will settle versus their original allocation counterparty at the original price outside the clearing corporation. Members must therefore continue to submit Notifications of Settlement (NOS) to the clearing corporation to close out the TBA trades that remain open in the FICC system. For these settlements, associated mark and margin could be returned to members on NOS matching date plus one. Fails Fails on pool delivery obligations versus FICC as CCP will remain on FICC s books throughout their lifecycle at the uniform price that was in effect on the date the delivery obligation was generated. This will preclude members from having to reinstruct their clearing banks on a daily basis with the new settlement values for the obligations. Actions Members May Take on Previously Submitted Pool Netting Input DK (Don t Know) DK input (via messaging or RTTM Web) will be used by both sellers and buyers to inform their counterparties that they do not know (or disagree with) the terms of pool netting input submitted against them. DKs may be submitted into Pool Netting at any time prior to matching. Affirm Members will have the ability to Affirm Advisories for pool netting data submitted against them using an Affirm function on the RTTM Web. (Affirm capability will not be supported by messaging.) By Affirming an Advisory, the member agrees to all pool netting data submitted by its counterparty on input, and the pool netting input will be placed in Matched status and the associated pool will be pended for Pool Netting. (The member that affirms the Advisory does not need to submit pool netting input to RTTM for bilateral matching. The Affirm itself effects matching.) Cancel Prior to matching, the buyer or seller may cancel its pool netting input unilaterally via messaging or RTTM Web (using a unique identifier on input to target the pool netting data). Once the pool data has been matched, the seller retains the ability to cancel the matched pool data unilaterally via messaging or RTTM Web up until the time of Pool Netting. Pool Substitutions Pre and Post Pool Netting Before Pool Netting is run, sellers will have the ability to substitute a previously submitted pool via RTTM using Interactive Messaging or RTTM Web. Once Pool Netting has been run and net pool obligations have been generated with FICC as the CCP on all net obligations, if a seller wishes to substitute a pool on an obligation, the substitution must be submitted using the 5

6 existing EPN pool substitution message. The seller must include a unique identifier on input targeting the net pool obligation to be substituted, and must submit FICC as the trade counterparty. The system will send the pool substitution to Pool Netting for processing. Pool Netting will ensure that the substitution targets a valid net pool obligation, and that both the original and replacement pool(s) pass all edits. If all edits are passed, the targeted pool obligation will be canceled and a new obligation will be established for the replacement pool(s). Messages will be sent to both the submitter and its original allocation counterparty (as determined by FICC) notifying them that the substitution has successfully updated. If the substitution does not pass all edits and can not be processed, FICC will send a DK to the submitter via EPN. Substitutions of pools that were not included in Pool Netting can be submitted via EPN; the substitutions will take place directly between the counterparties. Modify Non-Economic Terms Members will have the ability to modify their X-Ref in RTTM via messaging or RTTM Web at any time prior to Pool Netting. (Members will not have the ability to modify any other data.) Customer Delivery Requests (CDRs) and CDR Releases 48 hour day until just prior to Pool Netting on the evening of 24 hour day Members will have the ability to request priority delivery of a pool by submitting a CDR for the targeted pool data. Pools in a CDR state would result in the associated pool(s) being made established as a priority delivery if the pool is Pool-Netting eligible (i.e., the pool would be precluded from operational netting). A member will also have the ability to submit a CDR Release, effectively canceling the priority delivery request. CDRs and CDR Releases for individual pool inputs will be supported via messaging and RTTM Web. CDRs and CDR Releases will also be supported for broader application across multiple pool inputs simultaneously via RTTM Web only. Specifically, using RTTM Web, a member may submit a CDR for all pools having a specific pool number, or all pools associated with a specific TBA CUSIP. Participant Fund Enhancements FICC requires clearing members to post sufficient collateral to the Participant Fund in satisfaction of their daily margin requirement. The Participant Fund is designed to ensure FICC has sufficient assets on deposit to cover any liquidation losses that it would incur as a result of a member s insolvency. Concurrent with the implementation of CCP Pool Netting, cross-margining between MBSD and GSD portfolios will be provided. With the introduction of this enhancement we anticipate the total FICC-wide margin requirement for members that have outstanding positions across both Divisions will be lowered for cross-marginable positions. The exposure created by FICC s guaranty of Principal and Interest (P&I) payments on trades that fail over record date will also be included as part of the Participant Fund margin requirement calculation (see the following section Fed Fail Tracking for more details). In addition, as part of the risk management process, all outstanding trades and obligations will be marked-tomarket on a daily basis to reflect current market conditions. If the difference between a pool s settlement value and its current market value results in a debit mark, it will be added to the member s Participant Fund margin requirement. Inversely, if it results in a credit mark, it will be used to (partially) offset the Participant Fund margin requirement. A cash mark-to-market pass through is not being implemented as part of this release in order to 6

7 simplify members development efforts while continuing to account for market risk in an effective and prudent manner. Fed Fail Tracking To reduce development efforts required by member firms, FICC s service will supplement the existing Fed Fail Tracking system rather than replace it. For pool obligations that fail over record date, the Fed Fail Tracking system collects the Principal and Interest (P&I) from the seller and passes it through to the buyer on settlement date plus 1 or payment date, as appropriate. For novated trades that remain in a failed state for more than six months, FICC will pass through any P&I debits/credits that are not processed by the Fed Fail Tracking system on settlement date plus 1, thus eliminating the need to exchange manual P&I claims. FICC will provide an additional benefit by guaranteeing all P&I payments related to fails without disturbing the existing Fed Fail Tracking payment process. The risk associated with this guaranty will be included in the member s Participant Fund margin requirement. Once members are paid P&I via Fed Fail Tracking, FICC will release the corresponding collateral held in the Participant Fund to the members. Funds-Only Settlement Transaction Adjustment Payments, or TAP, which are used to close the gap between the uniform system prices assigned to the pool obligations and the individual pool contract prices comprising each obligation, will be settled daily as part of the members MBSD Funds-Only Settlement. This coincides with performing CCP Pool Netting on a daily basis to accommodate settlements associated with late allocations and substitutions where the delivery date for an obligation is changed. All other funds settlements will continue to be collected as they are today on specific days each month, generally corresponding to the four settlement dates associated with the TBA Netting cycle. Loss Allocation and Buy Side Membership The Government Securities Division (GSD) of FICC, which currently provides full CCP services to its members, uses a loss allocation model that was developed primarily for the dealer sell side community. This model is predicated on a process that allocates liquidation losses to the insolvent member s recent counterparties first. Under certain remote circumstances, it also allows for the mutualization of liquidation losses to other clearing members. This is in contrast to the current MBS loss allocation model, which is predicated on a process that allocates liquidation losses only to the insolvent member s original contra-sides, without the possibility of mutualizing liquidation losses to other clearing members. In order to implement CCP Pool Netting services while accommodating members that are precluded from mutualizing liquidation losses, FICC is developing a loss allocation model that is based on a two-tiered membership structure. This new model will combine existing concepts of both Divisions to allocate losses fairly and equitably to all parties involved and to meet each member s needs while protecting the membership as a whole. Additional information will be released pending further analysis and approval. Specific admission standards, as well as other requirements and responsibilities, will be established for a number of membership categories within each tier. While FICC will make every attempt to accommodate the existing MBSD members under this structure, each member will be required to meet the admission standards established for its corresponding category in order to participate in the new services. FICC is currently working on a service transition plan aimed at migrating MBSD clearing members to the appropriate membership category as efficiently and prudently as possible. It should be noted that EPN-only members will not be eligible for CCP Pool Netting. 7

8 Messaging and Reporting To the extent possible, FICC will leverage the single communications pipeline and the common International Organization for Standardization (ISO) formats that are in place for most fixed income products today. FICC will also work with existing MBS messaging and reporting streams, which will be modified to capture additional information, as required, to support the new services. Members will have the ability to monitor their pool netting input via RTTM Web, and may access expanded print image reports via the Report Center. Reporting and messaging requirements will be more fully defined in conjunction with our membership as we develop the Detailed Service Description and Interactive Messaging Specifications. ISO-based Messaging Messaging for Pool Netting will conform to existing RTTM Interactive Messaging guidelines used for TBA trade matching. ISO-based Messages may be transmitted in real-time (interactively) or in batch. As noted in the Service Overview, Messaging Specifications will be published in Q3, and proprietary messaging will not be supported. Briefly summarized, members will use the ISO MT515 Instruct message format to submit pool data into RTTM for bilateral matching against counterparty input. An Advisory (Comparison Request) message will then be sent to the trade counterparty using the ISO MT518 message format. Any change in trade status will be communicated to participants using the ISO MT509 message format (for example, to notify members when their pools are matched). The ISO MT515 message format will also be used to perform the following actions on previously submitted Instruct messages: 1) a message to submit Non-Economic Trade Data Modifications (i.e., to modify the x-ref submitted on the Instruct ); 2) a message to submit and to remove Customer Delivery Requests ( CDRs ), which can be used by members to preclude pools from operational netting; 3) a message to Cancel a previously submitted Instruct ; 4) a message to DK a previously submitted Instruct ; and 5) A message to substitute an Instruct prior to Pool Netting. RTTM Web RTTM Web is envisioned as a key tool for firms to view and monitor their respective pool netting statuses throughout the processing lifecycle (from point of initial submission to Pool Netting) for both long and short positions. In addition, RTTM Web will support all inputs required for Pool Netting, including: 1) Instruct; 2) Affirm; 3) Non-Economic Modify; 4) Cancel; 5) DK; 6) Substitution; 7) CDR; and 8) CDR Release. Print Image Reports via Report Center FICC will develop print image reports to support CCP Pool Netting and will leverage existing reports wherever possible. Contact Information The CCP Pool Netting initiative will provide an important new service to MBS customers and underscores the ongoing mission of DTCC and FICC to develop products that leverage technology to provide greater value for our customers and the industry, while enhancing processing efficiencies and reducing costs for our members. As noted in the Introduction, a Detailed Service Description and Interactive Messaging Specifications will be published in Q3. As always, FICC is interested in comments from its MBS clearing members and other industry participants on these new services. Any such comments should be directed to Murray Pozmanter at or Dennis Paganucci at , or send written comments via to mpozmanter@dtcc.com or dpaganucci@dtcc.com. 8