International Financial Law: The Case Against Close-Out Netting

In financial transactions today, a practice called “close-out netting” plays a key role in controlling and allocating risks. If anchored in the parties’ chosen contractual language and recognized by law, close-out netting can circumvent normal bankruptcy processes by providing for the acceleration of mutual obligations and the efficient calculations and settlement of the net balance. When correctly implemented, close-out netting can eliminate the risk that arises under ordinary bankruptcy principles. Despite the support for close-out netting by lenders, scholars, regulators, and policy makers, a few attentive observers of financial law argue that close-out netting is unsound, and the argument against close-out netting warrants further consideration. Following a brief description of the landscape of international financial law, arguments in support of and against the practice of close-out netting can be examined. These examinations show that, while there are legitimate arguments in favor of close-out netting, there are also real concerns about whether those arguments have been overstated and whether expansive legal protection for close-out netting exacts too high a cost. Further, it becomes clear that these competing considerations cannot be mathematically weighed and balanced because the relevant risks are difficult or impossible to measure. Therefore, lawmakers must exercise sound judgment regarding the degree of legal recognition that should be afforded to close-out netting. There are no clear answers, but there are certainly red flags which should not be ignored