How do TBA Futures and Forwards Compare?

The mortgage-backed securities (MBS) market has $12 trillion outstanding, approaching the size of the Treasury nominal coupon market which has $18 trillion according to SIFMA. Risk transfer primarily occurs in the To-Be-Announced (TBA) MBS market, accounting for more than 90% of trading volumes. CME Group’s 30-Year UMBS TBA futures allow market participants to manage exposure to agency MBS with the capital efficiency of an exchange-traded, centrally cleared, and globally accessible liquidity pool, provide many benefits of using futures to manage exposure to the second largest fixed income market in the U.S.

Table 1: Comparison of TBA futures and forwards

	TBA forwards	TBA futures
Trade venue	OTC (RFQ)	Exchange-traded (CLOB, blocks, EFRPs)
Quoted size	$1M face value (typically)	$100K face value
Central counterparty	MBSD of FICC or bilateral uncleared	CME Clearing
Coupon stack	1.5% to 8.5%	2% to 6.5%
Margin	Margin requirements for FICC clearing members, but not their clients. No margin savings through portfolio margining with ETDs.	Margin requirements for CME clearing members and clients. Margin savings through portfolio margining with ETDs.

Trading TBA futures and forwards

Trade venue

The TBA forward market operates primarily on a Request for Quote (RFQ) basis where market participants request markets from dealers over the phone or using an electronic trading platform. The Dealers limit which counterparties they deal with to manage counterparty credit risk exposure and may quote different markets to different market participants, depending on their relationship. TBA futures primarily trade through a central limit order book (CLOB) on CME Globex, as well as through blocks and Exchange for Related Positions (EFRPs). On a CLOB, market makers stream quotes on-screen that are accessible to all market participants. This provides equal access and price transparency to all market participants that is not available in the OTC market.

Quoted size

TBA forwards are typically quoted in increments of $1 million face value. TBA futures are quoted in increments of $100,000 face value (the notional size of the contract). This smaller contract size allows market participants to access liquidity in more granular sizes to suit their needs. It also simplifies the trading of inter-commodity spreads against Treasury futures, which have the same contract size, except for 2-Year and 3-Year Treasury futures, which have a $200,000 notional size.

By contrast, CME 30-Year UMBS TBA futures are open to trade long after and before TBA forwards for outright securities, coupon swaps/spread, and roll/calendar spreads markets. CME TBA futures can be traded using blocks and EFRPs, opening additional liquidity. For example, a customer could establish a basis trade by executing an EFRP transaction with a TBA future on one side and an equal and opposite position in an MBSD-cleared 30-Year UMBS TBA. The TBA basis spread coupled with EFRP functionality provides relative value traders a rich opportunity to arbitrage the basis spread between the forwards and futures. Each contract is deliverable into a MBSD-cleared 30-Year UMBS TBA at a given coupon rate.

Coupons

TBA coupon rates vary in 50-basis-point increments, consistent with the standards of the underlying UMBS issuers (Fannie Mae and Freddie Mac). Currently, CME Group lists coupons from 2.0% to 6.5%, which adequately facilitates trading in the most active coupon rates traded in TBA forwards. The wide range of available coupons is a product of the significant increase in mortgage rates over 2022. While the mortgage-backed securities division (MBSD) at the Fixed Income Clearing Corporation (FICC) – the central counterparty for TBA forwards – supports coupons ranging from 1.5% to 8.5%, very little trading occurs in the tails of this range.

Counterparty credit

In the OTC market, customers generally limit which counterparties they deal with to manage counterparty credit risk exposure. Customers and dealers/market makers deploy the directed RFQ model to help them manage counterparty exposures. The numbers are highly concentrated due to a smaller number of market markers that are willing to make markets in the Agency MBS TBA market. For example, as of April 28, 2023, Tradeweb had nearly three times as many U.S. Treasury liquidity providers (U.S. Government Bonds), 37, than for their TBA markets (TBA-MBS), 13.

On the CME Globex CLOB, it can be anyone taking the other side of the trade, in addition to the dedicated market makers that stream prices continuously during U.S. trading hours. For example, it could be a mortgage servicer on one side and a mortgage originator on the other side. CME Clearing serves as the counterparty to every cleared transaction, becoming the buyer to each seller and the seller to each buyer, and limiting credit risk by guaranteeing financial performance of both parties.

Margins

The benefits of central clearing require sufficient margin. CME Group’s experience and expertise provide exceptional safety, clarity, and ease with low cost on an outright or Treasury spread. The OTC market has non-standard practices to attempt to reduce credit risk, and while regulation has been established to increase margin requirements, but it has not yet been enforced.

Margins for OTC TBAs-Proposed Amendments to FINRA Rule 4210

If and when they become effective, changes to FINRA Rule 4210 will require daily variation (mark-to-market) margins to be collected by broker-dealers from their accounts for most bilateral trades that aren’t cleared by MBSD. TBA trades cleared by MBSD are already subject to margining by DTCC.
New margin rules are consistent with 2012 recommendations of the Treasury Market Practices Group (TMPG), convened by the Federal Reserve Bank of New York
Initial margin of 2% required for smaller, non-exempt accounts
No margin collected if amount owed by a single counterparty is $250,000 or less, which may create issues for investment advisors with managed accounts because it appears to be at the level of the legal entity
Buy-side accounts will likely need to renegotiate MSFTAs with broker-dealers.
The governing agreement for trading and margining of forward-settling agency mortgages is the Master Securities Forward Transaction Agreement (MSFTA). The agreement sets guidelines and definitions to control the execution, settlement, and margining of trading in the TBA market.

As of April 19, 2023, initial margin requirements for TBA futures were less than 4% of the contract notional value across the coupon stack. For example, the 3.5% coupon was the highest at $3,960 per contract. The 4.5% to 6.5% coupons were the lowest at $3,520 per contract. Please refer to the chart below for the initial margins for TBA futures by coupon.

Initial Margins for TBA futures by Coupon as of April 19, 2023

While FICC requires its clearing members to post margin on TBA forwards, not all participants clear their trades at the FICC. Although FINRA has proposed rule changes that would require clients to post margin on TBA forwards, the changes have been continually delayed since approved by the SEC in 2016.^[1] As a result, many market participants are not required to post margin on TBA forwards. While market participants are required to post margin on TBA futures trades, the combination of TBA futures positions with other exchange-traded derivative (ETD) positions in portfolio margining, including Treasury futures and Eris swap futures, can lead to lower overall margin requirements.

For example, the total margin requirement for a portfolio consisting of a long position in 10-Year Treasury Note (TY) futures and a short position in 30-Year 5% UMBS TBA futures (50U) is less than the margin requirement for a standalone long TY position. Using CME Clearing margin requirements on April 25, 2023 (given in the table below), the margin requirement for a long TY position is $2,475 per contract, while the total margin requirement of a portfolio that combines a short 50U position is:

($2,475 + $3,520) * (1 - 70%) = $1,798.50

Table 2: TBA futures margin requirements ^[2]

	Initial Margin Requirement	Margin Offset
10-Year Treasury Note futures	$2,475	70%
30-Year 5% UMBS TBA futures	$3,520	70%

CME Group base level initial margins can be lowered significantly by establishing opposite/contra positions that reduce the risk of the TBA position:

For rolls/calendar spreads, initial margin of $660
For coupon swaps, spread credit of at least 75%
For Eris SOFR Swap futures, spread credit of 65%

For comparison purposes, Treasury futures currently have similar initial margins, ranging from 2.5% to 7.2% for long-term Note and Bond futures, for the fixed income futures with the deepest liquidity and longest history.

For TBA futures, as for all futures contracts cleared by CME Group, the margins are set by the Clearing Firm. They are typically equal to or higher than the minimum margins set by CME Clearing.

CME Group initial margins and margin offsets are based on multiple risk-based factors, and they are subject to change. Initial margins and margin offsets in this paper are as of April 19, 2023, and April 25, 2023. The potential savings discussed above are examples used for illustrative purposes and are not intended as a guarantee of actual savings. Individual savings will vary based on each market participant’s unique portfolio and risk exposure.

Converging to cash

On the following pages, we provided final futures and cash settlement histories for 30-Year UMBS TBA coupons ranging from 2.0% to 6.0% for the December 2022, January 2023, February 2023, and March 2023 contract months. The 6.5% coupon is not included due to the lack of history beginning with the May-23 contract month. These prices are the final settlement prices for each of our TBA futures and the corresponding TBA cash market price on the futures last trading day (LTD).

This drives home the many positive features of TBA futures. Empirically, the cash futures basis trades tightly into delivery, EFRP ability provides relative value trading opportunities. A broad coupon stack and three listed months allow market participants the ability to roll, take delivery, and risk manage mortgages with all the safety of exchange listed products and a central limit order book.

Please refer to the charts below for the price histories for Dec-22 through Mar-23 contract months for the coupons ranging from 2.0% to 6.0%. Nearly all produced futures and cash settlement price differences of 0.05 point or less, 33 of 34 settlements.