News Column

"TBA Futures Contracts and Central Counterparty Clearing of TBA" in Patent Application Approval Process

August 30, 2014

By a News Reporter-Staff News Editor at Investment Weekly News -- A patent application by the inventors Barker, Peter (Chicago, IL); Culverhouse, Morgan (Chicago, IL); Grannan, Larry (Chicago, IL), filed on April 11, 2014, was made available online on August 14, 2014, according to news reporting originating from Washington, D.C., by VerticalNews correspondents.

This patent application is assigned to Chicago Mercantile Exchange Inc.

The following quote was obtained by the news editors from the background information supplied by the inventors: "The present invention relates to systems and methods for managing trading of investment vehicles, and particularly, to-be-announced (TBA) instruments.

"Mortgage backed securities (MBS) are bought and sold through different market mechanisms. Some mechanisms include a pass-through MBS issued by or guaranteed by institutions such as Fannie Mae, Freddie Mac and Ginnie Mae. A pass-through security may be created when multiple mortgages are pooled together and sold as undivided interests. The mortgages generally have similar characteristics, such as loan type, maturity and interest rate. An originator, such as a lender, services the mortgage and passes the principal and interest through, less a servicing fee, to a MBS issuer. The mortgages may be packaged by the issuer and sold to investors. The principal and interest, less guaranty and other fees are thus passed through to the investor. The investor receives a share of the resulting cash flows.

"The pass-through securities, or MBS, may trade on a to-be-announced (TBA) market. A TBA contract is an underlying contract to buy or sell a MBS that is delivered at a predetermined future date. Under the TBA contract, the seller promises to deliver MBS on the future settlement date and a purchaser agrees to acquire a specified dollar amount of MBS. The contract is satisfied when the seller delivers the MBS pools at settlement. Thus, a mortgage lender may use a TBA contract to lock in an interest rate on loans it will fund before the loan is closed.

"In a TBA market, MBS are traded on a forward or delayed delivery basis with settlement up to 180 days later. The actual mortgage pools comprising the MBS are not specified at the time of sale. In fact, many of the mortgage loans may not even be signed (and the mortgage pools created) at the time of sale. The largest volume of trading in the TBA market is for settlement within 30 days.

"The parties to a TBA trade may agree to the type of security, coupon, face value, price, and settlement date at the time of the trade. During a period of time before the settlement date, such as 48 hours before settlement, the seller specifies or allocates the identity and number of mortgage pools to satisfy the TBA trade. Therefore, a mortgage originator may have until 48 hours before the settlement date to decide whether to use new pools of mortgages or to buy outstanding MBS to cover the trade.

"In the TBA, trades may take place some time before the actual settlement of the transaction and underwater positions are subject to very high margins of up to 130% which are administered by the clearer of the TBA market, the Mortgage Backed Security Clearing Corporation (MBSCC) which is a subsidiary of the Fixed-Income Clearing Corporation (FICC). The MBSCC is an organization that provides netting and pool notification services to the mortgage-backed securities market.

"Each day the MBSCC gets the closing prices for each forward MBS and determines the mark to market for margining. For example, if a position netted out to show a loss of $1 million, a clearing firm would have to post $1.3 million. Initial/base margins are said to be $250,000 plus an additional 32 basis points on your net position. If the net position is positive, this may be credited to reduce 32 basis point minimum on the net.

"TBA markets that provide security and saving from cross-margining for the trading parties are desired. Increases in trading efficiencies, pricing, execution, delivery and settlement of TBA contracts as well as the underlying MBS may increase liquidity and provide security for traders. Therefore, there is a need for systems and methods for administering, settling, and clearing of traded TBA instruments."

In addition to the background information obtained for this patent application, VerticalNews journalists also obtained the inventors' summary information for this patent application: "By way of introduction, a system, apparatus, and/or method for administering, settling, and clearing TBA instruments provides a centrally cleared, guaranteed, and settled market for exchange listed TBA futures. In an aspect of the invention, mark-to-market gains may be monetized for the TBA instruments. Embodiments may be achieved by, among others, one or more devices, systems, networks, and/or processes for administering, communicating, managing, placing, entering, receiving, matching, clearing, settling, listing and/or confirming orders for TBA Futures.

"In an exemplary embodiment, the TBA futures include coupons corresponding to those offered in a TBA market for Class A MBS that are exchange-listed. The coupons may have a par value 100 basis points above and below a current market rate for the corresponding TBA contract. For example, if the Class A mortgage rate is offered at 6.00%, one listed rate for trading will be 5.00% and another will be 7.00%. Additional or less coupons may be added for market conditions. The coupons are traded on an electronic trading system such as the Globex.RTM. electronic trading system.

"Pricing of the TBA Future is determined in multiples of one-quarter of one thirty-second ( 1/32) per 100 point. ($78.125 rounded up to the nearest cent per contract). Intermonth spreads may have minimum price fluctuations in multiples of one-eighth of one thirty-second point per 100 points ($39.0625 per contract). Par is determined on the basis of 100 points.

"An expiring TBA future may be settled with a position in the corresponding TBA contract (i.e., the Class A TBA market). For example, an expiring October 2006 CME 5.5% TBA future may be settled with a position in the October 2006 5.5% Class A TBA market.

"Trading may occur on the TBA futures until a predetermined time period before the settlement date, during which trading may no longer occur. In an embodiment, trading may cease on the TBA future on 5th business day before the settlement date for a Class A 30-year MBS as identified in the schedule posted by the Mortgage Backed Securities Clearing Corporation division of the Fixed Income Clearing Corporation.

"For example, if FICC has designated a particular day as the delivery day for Class A MBS TBAs, the last trading day for the corresponding TBA Futures would be five days prior to the designated date. After the expiration time, the long and short positions may be netted and counterparties for each open position identified. Each party having an open position in the TBA future may receive delivery instructions. The delivery instructions indicate the party's position, the issuer of the MBS (e.g., FNMA, Freddie Mac), coupon, contract settlement price, and opposite firm or identified counterparty. The parties thus receive notification of their delivery obligations. A delivery confirmation may be sent to the central counterparty for the TBA Futures confirming that the TBA trades conforming to the delivery instructions have been executed.

"In an aspect of the invention, a method and system are provided for settling TBA futures contracts. At a central counterparty, open positions in a TBA future market may be determined prior to expiration of a TBA future. Outstanding long and short positions may be cleared and counterparties identified for those positions that will be settled through delivery. The counterparties may be notified of open positions to be settled through delivery.

"The foregoing summary is provided only by way of introduction. The features and advantages of the TBA futures and systems for administering, communicating, managing, placing, entering, receiving, matching, clearing, settling, presenting, listing and/or confirming orders for TBA futures may be realized and obtained by the instrumentalities and combinations pointed out in the claims. Nothing in this section should be taken as a limitation on the claims, which define the scope of the invention. Additional features and advantages will be set forth in the description that follows, and in part will be obvious from the description, or may be learned by practice of the present invention.


"Examples of the invention are described with reference to the accompanying drawings, in which components, features and integral parts that correspond to one another each have the same reference number, wherein:

"FIG. 1 shows an exemplary system that may be used to implement aspects of a TBA future in accordance with an aspect of the invention;

"FIG. 2 shows an exemplary system that may be used to match orders for a TBA future in accordance with an aspect of the invention;

"FIG. 3 shows a exemplary method that may be used to match orders for TBA futures in accordance with an aspect of the invention; and

"FIG. 4 shows an exemplary method for clearing and settling open positions for TBA futures in accordance with an aspect of the invention."

URL and more information on this patent application, see: Barker, Peter; Culverhouse, Morgan; Grannan, Larry. TBA Futures Contracts and Central Counterparty Clearing of TBA. Filed April 11, 2014 and posted August 14, 2014. Patent URL:

Keywords for this news article include: Banking and Finance, Finance and Investment, Chicago Mercantile Exchange Inc..

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Source: Investment Weekly News

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