Multilateral Netting: What it is, How it Works

What Is Multilateral Netting?

Multilateral netting is a payment 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. When multilateral netting is being used to settle invoices, all parties to the agreement send payments to a single netting center, and that netting center sends payments from that pool to those parties to which they are owed. Therefore, multilateral netting can be thought of as a way to pool funds to simplify the payment of invoices between parties to the arrangement.

How Multilateral Netting Works

Multilateral netting can be employed to settle intercompany balances for subsidiaries of a company that transacts 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. Other benefits of multilateral netting include:

• Reducing intercompany cash flows to one each month for each subsidiary
• Simplifying payment schedules
• Streamlining invoice reconciliation between companies
• Streamlining the quarterly reconciliation of accounting ledgers
• Easier resolution of accounting mistakes
• Standardizing intercompany finance procedures
• Reducing the costs of cross-border money transfers
• Consolidating debt and obtaining better interest rates
• Enhancing the transparency of intra-firm financial transactions
• Consolidating local and non-local cash pools into a single pool
• Centralizing risk
• Optimizing funds use
• Making payment processes for group companies more efficient

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 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.

The National Securities Clearing Corporation (NSCC) acts as a centralized clearing and settlement location for the documentation of nearly all corporate equity and bond trades made in the U.S. stock market each day. Through the use of continuous net settlement (CNS), the NSCC accounts for trades made through members and processes them into single positions at the end of each trading day.

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. Furthermore, cash flow problems can arise when some member companies fail to pay by the agreed-upon due date.