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A well-functioning financial market has the following attributes:
“(1) Matching: Allows participants with diverse trading interests to be brought together efficiently and cost-effectively, so that they can adjust, share and redistribute financial exposures; and
(2) Price Discovery: Incorporates all relevant publicly available information in an appropriate, prompt and reliable manner, in turn generating meaningful price signals that, together with other features of financial markets, allow for an efficient allocation of resources.”
—Bank for International Settlements. (2019, October). “Large central bank balance sheets and market functioning.”
In this article, we discuss the emerging trading protocols and infrastructure for trading, processing and clearing MDX Swaps along with the benefits that accrue through this collective approach.
MDX Market Infrastructure and Trading
Market infrastructure and trading protocols reflect the needs and preferences of market participants in seeking to achieve the goals of a well-functioning market. To understand the optimal approach for trading MDX swaps, Vista undertook an in-depth review across a wide range of investors, dealers, insurers, issuers, banks and regulators.
A consensus has formed around the critical elements for MDX swap trading:
Reliable Fundamental Data
Central Clearing
Pre-Trade Indicative Pricing
Directed Requests for Executable Trading Prices
Straight-Through-Processing for Clearing and Reporting
Use of Existing Systems and Vendors
Reliable fundamental data regarding MDX reference borrower performance is sourced from Ginnie Mae, a government-owned corporation of the United States Federal Government within the Department of Housing and Urban Development. This loan data is available directly from Ginnie Mae (at no charge) or through various approved vendors. The largest of these third-party providers is ICE Data (formerly Black Knight), who is the computational agent for MDX indices. ICE Data offers complete coverage of both MDX index data as well as underlying loan level borrower data. All market participants will have timely access to this data.
Central clearing allows all market participants with the requisite capital to access trading without regard to counterparty risk1. Initial margin, transparent EOD pricing and daily mark-to-market payments ensure that diverse trading interests can be brought together efficiently and cost effectively on an open and level playing field. Post GFC, this is typical for macro derivatives. Clearing also enables regulatory supervision for market safety and soundness. MDX swap trading will be cleared at inception, enjoying these benefits and enabling use across a broad range of market participants.
Indicative pricing and request for quote (“RFQ”) protocols are used widely in other macro markets including Agency TBAs, CDX, and US Treasuries. The purpose is to provide pre-trading market guidance to investors and then allow counterparties to choose their dealers. Market participants are familiar with this approach and recommended that indicative pricing followed by firm quotes was preferable to live, executable prices – particularly as MDX swap trading begins. Likewise, market feedback indicated a strong preference for electronic platform trading over messaging runs and voice transactions.
Straight-Through-Processing (“STP”) is the norm in most major markets. To facilitate STP, most trading platforms connect directly to electronic booking systems for trade processing and clearing. Mortgage credit products today are not traded electronically and therefore do not benefit from efficient STP workflows that incorporate pre-trade clearing counterparty checks, automated booking, clearing and reporting. STP ensures no broken trades, minimal unintended trades, immediate clearing and lower transaction costs.
Existing systems and vendors have been consulted and are preparing to serve the needs of MDX swap trading. Vista, working with its partners and vendors, designed MDX swaps specifically so that they can be fully incorporated within internal systems and well-established vendors. These platforms span analytics, trading, operations and risk management. In the coming months, Vista will be introducing the vendors that will be supporting MDX swap trading so market users can engage directly with them.
Building a successful market infrastructure involves embracing the entire required ecosystem. By doing so, market participants can be assured of accurate, timely data; transparent pricing; fair access to markets; and cost-effective, reliable execution to settlement workflow so that the wide audience of diverse interests can be matched efficiently.