The latter one is quite well explained but I dont particularly understand the former one - settlement netting risk. Anyone has a sense of it? What is the difference between them and eg settlement risk? Cheers
Settlement netting risk is when at settlement, the other party defaults ( Herstatt risk) while you are expecting the payment from them (netted). Usally applied to interest rate swaps. While performance netting risk applies to the total retrun swaps when the performance of index is netted against other or something else- because it’s the perfromanance which is netted and settled.
Hopr that helps.
IIRC performance netting is when 1 manager loses your fund $1B and another makes $1B. You gained nothing net, but you’ve to pay the second manager his cut of the 2-and-20% anyway, and you can’t recoup that from the first manager,
derswap - you might want to check up.
herstatt risk is SETTLEMENT RISK - not Settlement Netting Risk.
Settlement netting risk - risk that the liquidator of a counterparty in default could challenge a netting arrangement so that the creditors get a better deal.
Performance netting risk - multimanager strategy - 2 managers - one earns a profit of 10 M$, one earns a loss of 10 M$. company as a whole has broken even - but because they have so signed the contract - the manager with a profit gets paid a performance bonus fee. so company as a whole incurs a loss.
Settlement risk (Herstatt) - counterparty to a deal declares bankruptcy while the other party has already made arrangements to pay this company. Co A declares Bankruptcy. Co. B pays it 1 M per the terms of its contract. if B had not paid - the 1 M may have been pardoned, or reduced. now B has paid A - and that money would be used to pay the other creditors of A.
Settlement net risk would it be then related bankruptcy? What would be actual application?
it is related to bankruptcy. bankruptcy court asks folks to net their payments and A pays B or B pays A as the case might be. Some other party C that did not get such a good deal - might challenge the netting arrangements done - so it could also participate in the distributions. The risk that such could occur is settlement netting risk.
Perfect, thanks Cpk! All these marginal at most things hopefully will make a change…