Gregory, Ch3 (Ch9 GARP): Netting

[enjofaes]

Hi David,

Just a question about netting. Could you perhaps provide an example of netting that imposes higher losses for certain credtors.
Legal risk is mentioned in the notes but in the video you've also mentioned that it imposes other creditors to more significant losses.

Many thanks in advance!
Kind regards,
Enjo
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Again a happy new year! Let's make the most of the year with FRM2 on the resumé

 

[enjofaes]

*might need a move to paid customers

 

[David Harper CFA FRM]

HI @enjofaes I think that's a reference to Gregory's example (later) in "6.4.4. Netting Impact on Other Creditor". See diagram below. The base case (on the left) is without netting where B's position with respect to ...

• Party A (Derivatives creditors) is Asset = 140 and Liabilities = 200, and
• Other Creditors (Party OC) is Assets = 40 and Liabilities = 100. So overall Party B has Assets = 180 and Liabilities = 300

Upon default by Party B, the "without netting" base case implies 180/300 = 60% overall recovery such that

• Party A receives payment of 60% * 200 = 120
• Party OC receives payment of 60% * 100 = 60

Alternatively under bilateral netting (but only for Party A, per image on the right), B's net exposure to A is 60 such that overall B has Assets = 40 and Liability = 60 + 100 = 160, and the overall recovery is 40/160 - 25% such that

• Party A receives payment of 25% * 60= 15
• Party OC receives payment of 25% * 100 = 25

Due to the ability of the the Derivatives creditors to net, the Other Creditors' recovery is reduced from 60 (i.e., 60%) to 25 (i.e., 25%). I hope that's helpful!