Netting

Business, Legal & Accounting Glossary

Definition: Netting


Netting

Quick Summary of Netting


Netting refers to the settlement of mutual obligations between two parties (called bilateral netting) or with a third party acting as a clearinghouse (called multilateral netting) where the net difference (not the gross amounts) is carried forward. Netting is a common practice in trading of foreign exchange, futures, and options.




What is the dictionary definition of Netting?

Dictionary Definition


Netting entails offsetting the value of multiple positions or payments due to be exchanged between two or more parties. Netting is used to determine which party is owed remuneration in a multiparty agreement.


Full Definition of Netting


Netting of cash flows or obligations is a means of reducing credit exposure to counterparties. Two forms of netting are widely employed in derivatives markets:

  • Payment netting reduces settlement risk: If counterparties are to exchange multiple cash flows during a given day, they can agree to net those cash flows to one payment per currency. Not only does such payment netting reduce settlement risk, but it also streamlines processing.
  • Closeout netting reduces pre-settlement risk: If counterparties have multiple offsetting obligations to one another—for example, multiple interest rate swaps or foreign exchange forward contracts—they can agree to net those obligations. In the event that a counterparty defaults, or some other termination event occurs, the outstanding contracts are all terminated. They are marked to market and settled with a net payment. This technique eliminates “cherry-picking” whereby a defaulting counterparty fails to make a payment on its obligations but is legally entitled to collect on the obligations owed to it.

With bilateral netting, two counterparties agree to net with one another. They sign a master agreement specifying the types of netting to be performed as well as the existing and future contracts which will be affected. Bilateral netting is common in the OTC derivatives markets.

Multilateral netting occurs between multiple counterparties. Typically, it is facilitated through a membership organization such as an exchange. Multilateral netting has the advantage that it reduces credit exposure even more than does bilateral netting. It has the disadvantage that it tends to “mutualize” credit risk. Because credit exposure to each counterparty is spread across all participants, there is less incentive for each participant to scrutinize the creditworthiness of each other counterparty.

While netting can be an effective means of reducing credit exposures, it can raise legal issues. Many jurisdictions do not recognize the enforceability of closeout bilateral netting agreements, arguing that such agreements undermine the interests of third-party creditors. Responsible legal counsel should be consulted before entering into any netting arrangement.


Netting FAQ's


What Is Netting?

The national securities clearing corporation (NSCC) employs netting to simplify securities transactions. To arrive at a net, the NSCC evaluates all buy and sell orders for each individual security and pairs purchases by one brokerage firm’s clients with equivalent sales by other brokerage firm’s clients.

Internally, the orders can be completed by updating the company’s books to reflect ownership changes. Firms with net short positions, whose clients sold more than they purchased, must send the required securities to the NSCC, or have them debited from their Depository Trust Corporation (DTC) custodial account for delivery to the NSCC, due to the small fraction of trades that aren’t netted.

Those shares are credited to firms with a net long position, meaning their clients bought more shares than they sold, according to the NSCC. To reduce the amount of money that must be traded among enterprises, the DTC nets the entire costs of buying and selling during the trading day. Firms with a net debit send money to the DTC, while those with a net credit get money.


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Definition Sources


Definitions for Netting are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 5th April, 2022 | 0 Views.