How do I calculate the benefit of close-out netting for a counterparty?

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AcadiFi · Accepted Answer

Close-out netting allows the surviving party at a counterparty default to terminate all trades in the netting set simultaneously and settle the net mark-to-market, rather than paying out all in-the-money trades while joining the queue for out-of-the-money trades. The benefit is the difference between gross positive exposure (sum of MTMs for trades where you're owed money) and net exposure (sum across all trades, floored at zero). For Farringham Meridian Trust with 140 trades, gross positive MTM might be $68M while net MTM is $22M — netting benefit is $46M or 68% reduction. Standard calculation. Gather all trades under the ISDA master with close-out netting. Compute MTM for each trade. Let Sum_pos = sum of positive MTMs, Sum_neg = sum of negative MTMs. Net = max(0, Sum_pos + Sum_neg). Netting benefit = Sum_pos - Net. Netting ratio = Net / Sum_pos (lower = better netting). For regulatory capital under IMM, effective EPE is computed at the netting set level with stochastic simulation, naturally capturing netting benefits through path-level offsetting. For standardized methods (SA-CCR), netting is recognized at a coarser hedging-set level with specific aggregation formulas. Legal enforceability is critical: netting only works if the master agreement is legally valid in the counterparty's jurisdiction — ISDA publishes opinions for 80+ jurisdictions. Cross-product netting (rates + credit + FX under one ISDA) produces the largest benefits; siloed ISDAs lose significant netting efficiency.

How do I calculate the benefit of close-out netting for a counterparty?

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