Netting

Bilateral derivatives markets have historically developed netting methods whereby parties can offset what they owe to one another. Most netting in the bilateral over-the-counter (OTC) derivatives market is supported by International Swaps and Derivatives Association (ISDA) agreements. Bilateral netting of OTC derivatives merely increases the recovery for OTC derivatives counterparties but reduces the recovery of other creditors. Netting has been critical for the growth of the OTC derivatives market and, without it, the current size and liquidity of OTC derivatives would not exist. Bilateral markets have used trade compression as a way to achieve multilateral netting. This has developed since OTC derivatives portfolios grow significantly through time but contain redundancies due to the nature of trading. When promoting central clearing, a key point made by policymakers and regulators is often that central counterparties (CCPs) facilitate multilateral netting, which can alleviate systemic risk by reducing exposures more than in bilateral markets.