Bilateral Netting - Explained
What is Bilateral Netting?
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Table of ContentsWhat is Bilateral Netting?How Does Bilateral Netting Work?Types of NettingAcademics Research on Bilateral Netting
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.
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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.