Insolvency Close-Out Netting

Abstract

This short paper, prepared for a colloquium on the Resolution of Financially Distressed Financial Institutions, explains insolvency close-out netting and its implications. The term refers to a special type of netting of offsetting derivatives obligations that entitles a derivatives counterparty, upon the occurrence of a bankruptcy or default relating to the other party, to terminate outstanding obligations and reduce the amounts mutually owing between the parties to a net amount. Although the purported goal of that netting is to reduce systemic risk, this paper critically analyzes the extent to which that occurs.