Foreign Currency Netting

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A company that regularly conducts business in multiple countries must spend a considerable amount of time settling foreign exchange transactions. It may buy and sell the same currencies many times over as it processes individual payables and receivables. There are three ways to reduce the volume of these transactions, depending on the number of parties involved. These foreign currency netting methods are:

Unilateral netting. A company can aggregate the cash flows amongst its various subsidiaries, to determine if any foreign exchange payments between the subsidiaries can be netted, with only the (presumably) smaller residual balances being physically shifted. This reduces the volume of foreign exchange cash flows, and therefore the associated foreign exchange risk.
Bilateral spreadsheet netting. If two companies located in different countries transact a great deal of business with each other, then they can track the payables owed to each other, net out the balances at the end of each month, and one party pays the other the net remaining balance.
Multilateral centralized netting. When there are multiple parties wishing to net transactions, it becomes much too complex to manage with a spreadsheet. Instead, the common approach is to net transactions through a centralized exchange. Under a centralized netting system, each participant enters its payables into a centralized database through an Internet browser or some other file upload system, after which the netting service converts each participant’s net cash flows to an equivalent amount in each participant’s base currency, and then uses actual traded exchange rates to determine the final net position of each participant. The exchange operator then pays or receives each participant’s net position, and uses the proceeds to offset the required foreign exchange trades.

Each type of arrangement can involve a broad array of payment types, covering such areas as products, services, royalties, dividends, interest, loans, and hedging contracts.

When bilateral or multilateral netting is used, the parties usually sign a master agreement which itemizes the types of netting to be performed, as well as which contracts or purchase orders are to be included in the arrangement.

Though foreign currency netting can be a highly effective way to reduce foreign exchange transaction costs, some governments do not recognize the enforceability of netting arrangements, because they can undermine the payment rights of third-party creditors. Consequently, consult a qualified attorney prior to entering into a netting arrangement.