What is Bilateral Netting?

Bilateral netting is a legal process of merging or consolidating all swap agreements between two parties into a single agreement. Through this process, all the swaps are netted together to create a single legal obligation, hence, rather than each swap agreement having an individual payment stream, a single net payment stream is created. A bilateral netting allows two parties with several legal contracts or swaps agreements to have a single agreement which is an aggregate of all other agreements. Aside that bilateral netting offers ease of contracts between counterparties, it also reduces the transaction or agreement volume between them.

How Does Bilateral Netting Work?

Literally, bilateral is having two sides of a thing, while netting is an act of combining or merging different threads to form a single meet. Bilateral netting facilities the reduction of the overall transactions between two parties because all the transactions are netted into a single one. One major advantage of bilateral netting is that it gives room for two parties in a legal contract to offset claims against each other and also determine the net payment of obligation that a particular counterparty is entitled to or liable for. A bilateral netting offers a reduction of the risk to the two counterparties involved in the agreement, these include liquidity risk, settlement risk, systemic risk, and credit risk. A bilateral netting also offers counterparties security in the event of bankruptcy. For instance, if a counterparty goes bankrupt, such party cannot collect in-the-money swap if out-of-the swaps are not paid in full. This means all out-of-the-money swaps must be paid in full before a party can collect on in-the-money swaps.

Types of Netting

• Multilateral Netting: Multilateral netting occurs between more than two parties.
• Novation Netting: This replaces all the swap agreements between the two counterparties with a new agreement called master agreement.
• Close-out Netting: This allows counterparties to terminate transactions after a default.
• Payment Netting: Also called settlement netting, is a netting where all original swaps are retained but each party adds up the amount owed the other party and only pays the difference in the amounts to the other party.