Close-out netting

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Be careful to distinguish between Settlement netting (also known as Payment netting) - which is an operational convenience gladly applied during the life of a derivatives trading relationship, and Close-out netting which is applied, with a heavy heart, by a non-defaulting party under Section 6 of the ISDA Master Agreement when things have turned to custard.

See — for a grossly cynical view — the Red Flag Act


Close-out netting is the process of doing that under a master agreement such as the ISDA Master Agreement when one party defaults. Because an ISDA Master Agreement may have many Transactions under it, some with positive and some with negative mark-to-market exposures, the ability to “net down” all these exposures to a single net sum is important when calculating risk weighting.

In order to achieve that “net” treatment under relevant regulations — there are a lot of them; locally, regionally, and under the Basel banking accords etc — one must have legal opinions from all relevant jurisdictions that the “close out netting” would be effective in the insolvency of the counterparty.

The difference between close-out netting and set-off

  • Close-out netting, in the learned words of Allen & Overy, is a contractual process comprising early termination, valuation and determination of a net balance. This last step may involve a contractual set-off but, saucily, the considered view of ISDA’s counsel for England and Wales is that the net effect of the agreement is to arrive a a net balance without the good offices of contractual set-off[1] According to the UNIDROIT[2], close-out netting resembles the classical insolvency set-off, but is purportedly wider: general set-off requires mutual debts that are already due, while close-out netting envisages the netting of obligations that are not yet due.[3] Thus, set-off is narrower that close-out netting.
  • Set-off is a legal principle permitting (or requiring) a debtor to discharge its debt by setting off a cross-claim owed to the debtor against the debt. There are various legal bases for set-off, including, under English law, equitable set-off, set-off in judicial proceedings under the Civil Procedure Rules, statutory set-off under the Insolvency Rules 1986 upon a winding upon administration and contractual set-off.

If a master agreement allows set-off, can I net down across master agreements?

So if one of my master agreements has a broad set-off provision (as well as its close-out netting provision), and my netting opinion says the set off (of amounts due under other master agreements) would also be enforceable, can I then treat all my exposures against that counterparty, across all master agreements, as nettable down to a single obligation?

Sorry to be the bearer of the buzzkill, but no. You need a “written, bilateral netting agreement that creates a single legal obligation, covering all included bilateral master agreements and transactions” (a “cross product netting arrangement”), itself supported by a netting opinion. See Rule CRE53.61-9 of the Basel framework[4] This might be, for example, the joint-association-published Cross-Product Master Agreement - and most prime brokerage agreements do this too.

But even if you have got a master netting agreement, also check whether your own firm’s operational systems are capable of recognising cross-product netting arrangements as a practical matter. From personal experience, the JC suspects many aren’t. If the computers can’t do it, your CPMA and your netting opinions are as good as a chocolate starfish.

Assignment and its effect on Netting and Set-off

Could a right to assign by way of security upset close-out netting such that one should forbid parties making assignments by way of security of their rights under a master netting agreement (such as an ISDA Master Agreement or a 2010 GMSLA), for fear of undermining your carefully organised netting opinions?

Generally: No.

  • An assignment by way of security is a preferred claim in the assignor’s insolvency over the realised value of certain rights the assignor holds against its counterparty. It is not a direct transfer of those rights to an assignee: the counterparty is still obliged to the assignor, not the assignee, and any claim the assignee would have against the counterparty would only be by way of subrogation of the assignor’s claim, should the assignor have imploded in the meantime or something.
  • Nemo dat quod non habet”:[5] the unaffected counterparty’s rights cannot be improved (or worsened) by assignment and, it being a single agreement, on termination of the agreement the assignee’s claim is to the termination amount determined under the Agreement, which involves terminating all transactions and determining the aggregate mark-to-market and applying close-out netting. No one can give what they do not have.[6]
  • The assignee can be in no better position than the assignor and this takes subject to any set-off. The conduct of the debtor vis a vis the assignee is irrelevant, unless it gives rise to an estoppel. See Bibby Factors Northwest Ltd v HFD Ltd (paragraphs 38 and 48).[7]

At the point of closeout, the assignee’s right is to any termination payment payable to the Counterparty. Therefore any assignment of rights is logically subject to the netting, as opposed to potentially destructive of it.

But: This is only true insofar as your netting agreement does not actively do something crazy, like disapplying netting of receivables which have been subject to an assignment and dividing these amounts off as "excluded termination amounts not subject to netting".

I know what you are thinking. "But why on God’s green earth would anyone do that?" This is a question you might pose to the FIA’s crack drafting squad™, who confabulated the FIA’s Professional Client Agreement, which does exactly that.

Netting between legal entities established in England and Wales

In November 1993 — not long after the publication of the 1992 ISDA, the Financial Law Panel (these days the Financial Markets Law Committee) published a Statement of the Law relating to Netting which, more or less, confirmed that not only is netting permissible between English entities on an insolvency; it’s compulsory, whether or not you have an ISDA Master Agreement. Therefore one doesn’t need a netting opinion for domestic English swap agreement. Hurrah.
For a discussion of what “closing out” is and how it works in various types of Master Agreement, see:

See also


  1. Sigh - except where there are unpaid amounts payable under Section 2(a)(i). You knew there’d be some kind of qualification though, didn’t you.
  2. “Principles on the operation of close-out netting provisions”
  3. The ISDA Master Agreement achieves this by accelerating them, mind.
  5. “A chap cannot give away what he doesn’t own in the first place.” Of course, try telling that to a prime brokerage lawyer, or a counterparty to a 1994 NY CSA.
  6. Except under New York law — isn’t that right, rehypothecation freaks?
  7. Bibby Factors Northwest Ltd v HFD Ltd [2015] EWCACiv 1908