Assignment of Trade - Explained
What is an Assignment of Trade?
Written by J. Mance Gordon
Updated at April 23rd, 2024
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What is Assignment of Trade?
An assignment of trade (AOT) is a tri-party agreement in the trade of mortgage-backed securities (MBS) in which a party in the initial agreement assigns his obligation to a third party. An assigned trade occurs when a counterparty in a forward contract or trade makes a separate deal with a third party to assign him his obligations. Assignment of Trade (AOT) can also occur in other trades where the seller who has an agreement with the buyer contacts a middleman or a broker-dealer to execute this transaction.
How Are Assignment of Trade Used?
In the United States, the Securities Industry and Financial Markets Association (SIFMA) has made AOT a formal process. Assignments of trade are used to avoid the need to deliver or receive deliveries from a To-Be-Announced (TBA) trade. Assignments can be used to facilitate the pricing and purchase of loans by a third party to whom the trade is assigned. Hence, the third party or assignee is responsible for making the delivery of a mortgage-backed security to the initial TBA trade. Through AOT, the originator of a mortgage can reverse its hedge position by assigning his obligations to a third party.
How does Assignment of Trade Work?
Essentially, AOT is a strategy that helps assignors eliminate risk by moving book mortgages. The assignor unwinds his hedge position in the MBS, the security must be delivered to the other party. Mr. A is an assignor who attempts to create a hedge against some risks related to a loan he issued. He enters a future contract with a broker in which he sells a mortgage-backed security to the broker for future delivery. Now, the broker is expecting to receive the security at a future date, and the assignor has the obligation to deliver the security. If the assignor then enters into a different agreement with an investor (assignee) who is interested in taking the loans and fulfilling the assignor's obligation to the broker, an assignment of trade has occurred. Once an agreement is made between the assignor and assignee, the assignee holds the loan, benefits from interest rates and profits of the loan but also faces the default risk of that loan. The assignee is also responsible for the delivery of the MBS to the broker at a future time.