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

Which statement best describes the effect of an unenforceable close-out netting agreement in a jurisdiction on a bank's counterparty risk measurement?

If close-out netting is not legally enforceable, the bank must measure exposure gross, summing only positive-value trades with no offset. An administrator could cherry-pick, so the netting benefit cannot be relied upon. Netting recognition requires legal certainty in the relevant jurisdiction.

  1. AThe bank should treat exposure on a gross basis, summing positive values without offsetting negatives, for that counterpartyCorrect
  2. BThe bank may still reduce exposure to the net amount because the contract wording is standard
  3. CThe bank's exposure falls to zero because the contracts are void
  4. DThe bank should apply netting only to trades within the same product type

Explanation

If legal opinion indicates that netting is not enforceable, an insolvency administrator could cherry-pick, so the bank can only rely on gross positive exposures. Netting benefit is recognised only with legal certainty.

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