Not only does such payment netting reduce settlement risk, it also streamlines processing. In the event that a counterparty defaults, or some other termination event occurs, the outstanding contracts are all terminated. They are marked to market and settled with a net payment. With a bilateral netting agreement, two counterparties agree to net with one another. They sign a master agreement specifying the types of netting to be performed as well as the existing and future contracts which will be affected.
Multilateral netting occurs between multiple counterparties.
Typically, it is facilitated through a membership organization such as an exchange . Multilateral netting has the advantage that it reduces credit exposure even more than does bilateral netting. Because credit exposure to each counterparty is spread across all participants, there is less incentive for each participant to scrutinize the credit worthiness of each other counterparty. Let's consider an example. Exhibit 1 illustrates non-netting commitments between three counterparties.