Close-out netting

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Premium content Here the free bit runs out. Subscribers click 👉 here. New readers sign up 👉 here and, for ½ a weekly 🍺 go full ninja about all these juicy topics👇 Close-out netting vs set-off Netting between legal entities established in England and Wales

See also

• For a discussion of what “closing out” is and how it works in various types of Master Agreement, see Early Termination under the ISDA Master Agreement and GMSLA Netting under the 2010 GMSLA
• Red Flag Act
• Automatic early termination
• Close-out Amount

References

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

Introduction

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.

===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”: 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.
• 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).

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. Template:Netting between english entities For a discussion of what “closing out” is and how it works in various types of Master Agreement, see:

• Early Termination under the ISDA Master Agreement
• GMSLA Netting under the 2010 GMSLA

See also

• Automatic early termination
• Close-out Amount