Template:M gen GMSLA 11.8

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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.

  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.
  4. ↑ https://www.bis.org/basel_framework/chapter/CRE/53.htm
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