Collateral Management

CHAPTER 30OTC Derivatives and Collateral – The Collateral Lifecycle – Post-Trading – Trade/Portfolio Netting

This chapter describes the possibility that a newly executed OTC derivative trade may be netted with an existing trade or position, providing all such trades have the same characteristics and are with the same bilateral counterparty. If netting does occur, this will reduce two or more gross trades to a net position, on which exposures will need to be calculated going forward in time, until the position’s scheduled maturity date is reached or earlier termination occurs.

Following formal agreement of the trade details with the counterparty, it is generally accepted as beneficial to both parties if a trade can be netted with another trade or with an existing position. Such netting is applicable to both buy-side and sell-side firms.

30.1 INTRODUCTION

Trade/Portfolio netting is the process of offsetting trades that contain the same details as an existing position in the same OTC derivative product and updating that existing position to a new net position, whilst terminating (cancelling) the original trades. This netting process is commonly known as portfolio compression.

The holding of OTC derivative trades to their scheduled maturity date, especially when trades have a lifetime of up to 50 years, carries significant annual maintenance costs and risks, which can be ...