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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

A risk manager is deciding whether a bank can recognise netting benefits for exposures to a counterparty in a new jurisdiction. Which condition is most critical for recognising close-out netting in exposure calculations?

The critical condition is a well-reasoned legal opinion that close-out netting is enforceable in the counterparty's jurisdiction, including insolvency. Without it, a liquidator could cherry-pick trades, so netting cannot be relied on to reduce exposure. Rating, product type and maturity are irrelevant to enforceability.

  1. AA legal opinion confirming netting is enforceable in the counterparty's jurisdiction, including in insolvencyCorrect
  2. BThe counterparty holding a high external credit rating
  3. CAll trades in the portfolio being the same product type
  4. DThe trades having identical maturities

Explanation

Netting benefits depend on legal enforceability, particularly in insolvency, where a liquidator might 'cherry-pick' favourable trades. Reasoned legal opinions address this. Rating, product type and maturity do not affect enforceability.

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