Fail to Settle U.S. Debt Trades on Time: Pay Fine
Wall Street firms failing to settle trades in agency debt and agency mortgage-backed securities on time will no longer get a free ride.
Effective February 1, they will have to pay a penalty of sorts based on a formula created in 2010 by an advisory committee of the Federal Reserve Bank in New York. Called the Treasury Market Practice Group, the committee consists of senior bankers from some of the world's largest securities firms: Morgan Stanley; Goldman Sachs; Barclays; Citigroup and JP Morgan Chase.
The fine covers debentures issued by the Federal Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal Home Loan Bank. The fine would also cover mortgage-backed securities issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association.
The new fines for failing to settle mortgage and agency-backed securities on time are similar to those proposed in 2009 by the TPMG for U.S. Treasuries. The goal of the fines is to reduce the number of failed transactions which the TMPG says can heighten market risk, create a loss of confidence between counterparties and lead to a daisy chain of failed trades. The TPMG is supported by the Securities Industry and Financial Markets Association, the trade group representing U.S. broker-dealers.
In the case of agency debt, the penalty would come to the greater of three percent per year minus the Fed funds rate for each day the trade fails to settle on time. In the case of mortgage-backed securities it would come to the greater of two percent per year minus the Fed funds rate for each day trades fail to settle on time; there is a two-day grace period for mortgage-backed securities.
The Fixed-Income Clearing Corp., a subsidiary of Depository Trust & Clearing Corp. says it will calculate and collect the fines for failed agency-backed transactions on behalf of its 65 broker-dealer and bank members. However, many fund managers which trade the debt with broker-dealer and bank counterparties have also voluntarily agreed to be subject to fines, if they are responsible for settlement fails. The same principles applied to U.S. Treasuries for which the FICC has collected fines for failed transactions. FICC won't say how much it has collected in aggregate, but insists the fines have substanitally reduced the number of failed transactions. FICC won't be collecting the fines for failed trades in most mortgage-backed securities because it doesn't act as the central counterparty; it will do so for a select few.
Trades fail to settle on time when a fund manager or broker-dealer doesn't deliver securities to a counterparty in time because they didn't receive those same securities from yet another party to settle in an unrelated transaction. One party's failure to deliver the same bonds to yet another buyer causes the third buyer to fail to deliver to yet another. The TPMG says that settlement fails can occur because of miscommunications on the details of the trade between buyers and sellers. A more common reason: a firm might be short the necessary bonds but not have sufficient financial incentive to borrow securities to make deliver. The new fines are meant to discourage firms from failing to deliver the bonds on time.
Fund managers, broker dealers and banks are clearly eager to reduce the fines they must pay so want fast information on how many trades are failing, why and how much it will cost them. Armed with that data, they can either change their own procedures or encourage counterparties to change theirs. Some are relying on electronic data aggregation tools while others are gathering information manually from internal position recordkeeping and settlement platforms, reflective of the lower volume of transactions they process. Fund managers also typically receive daily reports on fails from their custodian banks.
Financial technology giant SunGard and upstart Middle Office Solutions provide automated turnkey platforms to do much of the work. SunGard just announced that it has enhanced its Stream Fail Monitor platform, used by five broker-dealers, to handle the latest TMPG rules for mortgage and agency debt. SunGard will also calculate the penalties they must pay, generate an electronic claim form they can send counterparties and accrue interest on the claim. In the case of trades cleared through FICC, the clearinghouse will be sending out the claim form and collecting the fine to credit the injured party's account. Parties must pay of their aggregate penalties exceed $500 on a given business day.
"Our goal is to help brokers consolidate information that might otherwise be located in multiple systems and avoid the need for manual calculations on excel spreadsheets," says Tony Scianna, deputy head of strategy for SunGard's capital markets business in New York.
New York-based Middle Office Solutions says that its FailStation platform is used by twelve fund managers to receive reports from broker-dealers and custodian banks on any transactions that have failed in U.S. Treasury, mortgage and agency-backed markets and the reasons why. An additional 114 fund managers are using the platform for Treasury fails.
The TPMG has also come up with its own recommendations for how firms can reduce their number of failed trades in U.S. agency debt and agency mortgage-backed securities. The TPMG says that a failure stemming from a short positions can sometiems be prevented by borrowing the securities through the "dollar roll or delivering "more valuable" securities in its inventory. It says that settlement fails due to miscommunication or "other operational failures" are more difficult to eliminate.
Written by Chris Kentouris, Editor-in-chief (Chris can be reached through Chris.Kentouris@hotmail.com)
