Netting

This page is about the finance term. For the fabric called "netting" see Net (textile).

In general, netting means to allow a positive and a negative value to set-off and partially or entirely cancel each other out.

In the context of credit risk, there are at least three specific types of netting:^[1]

1. Close-out netting: In the counterparty bankruptcy or any other relevant event of default specified in the relevant agreement if accelerated (i.e. effected), all transactions or all of a given type are netted (i.e. set off against each other) at market value or, if otherwise specified in the contract or if it is not possible to obtain a market value, at an amount equal to the loss suffered by the non-defaulting party in replacing the relevant contract. The alternative would allow the liquidator to choose which contracts to enforce and which not to (and thus potentially "cherry pick"). There are international jurisdictions where the enforceability of netting in bankruptcy has not been legally tested.
2. Netting by novation: The legal obligations of the parties to make required payments under one or more series of related transactions are canceled and a new obligation to make only the net payments is created.
3. Settlement or payment netting: For cash settled trades, this can be applied either bilaterally or multilaterally and on related or unrelated transactions.

• Bilateral Net Settlement System: A settlement system in which every individual bilateral combination of participants settles its net settlement position on a bilateral basis.

• Multilateral Net Settlement System: A settlement system in which each settling participant settles its own multilateral net settlement position (typically by means of a single payment or receipt).

Netting decreases credit exposure and reduces both operational and settlement risk and operational costs.

In regards to the BASEL Accords, the first set of guidelines, BASEL I, was missing guidelines on netting. BASEL II introduced netting guidelines.

In the context of pollution control, netting refers to a procedure whereby a company can create a new pollution source only if it makes equal reductions in pollution elsewhere in the company, i.e. it cannot acquire new permits from the outside.

See also

• Clearing house (finance)
• Margin (finance)

References