Multilateral netting is an arrangement among multiple parties that transactions be summed, rather than settled individually. Multilateral netting can take place within a single organization or among two or more parties. The netting activity is centralized in one area, obviating the need for multiple invoicing and payment settlements among various parties.
Breaking Down Multilateral Netting
Multilateral netting can be employed to settle intercompany balances for subsidiaries of a company that transact with one another in different currencies. Instead of Subsidiary A in one country arranging payment to Subsidiary B in another country for an intercompany transaction, and Subsidiary B arranging payment to Subsidiary C in yet another country for another transaction, these subs can report to a central office or submit into a centralized system for netting. The benefits are clear: time saved and bank fees (for forex conversions) reduced. Also, the company consolidates a single transaction log with dates, currency conversion rates, and business transaction details, which helps to facilitate the work of auditors when they examine cross-border activity. The function can be performed in-house or outsourced to a third party.
Other Uses for Multilateral Netting
Multilateral netting can also be used by two or more entities that regularly transact with one another. The benefits are the same as those for a company with units that operate internationally. The arrangement not only streamlines the settlement process among third parties, but it also reduces risk by specifying that, in the event of a default or some other termination event, all outstanding contracts are likewise terminated. Multilateral netting is enabled via a membership organization like an exchange.
Disadvantages of Multilateral Netting
Although multilateral netting offers a host of advantages to member parties, it also has some disadvantages. To begin with, the risk is shared; hence, there is less incentive to evaluate the creditworthiness of each and every transaction carefully. Secondly, there are sometimes legal issues to consider. Not all closeout bilateral netting arrangements are recognized by law. In fact, some argue that such arrangements undermine the interests of third-party creditors.