Explain the importance of Multilateral Netting

Multilateral netting is a settlement mechanism used by companies (subsidiaries of a multinational enterprise) to pay for goods and services purchased from affiliated companies(subsidiaries of a multinational enterprise). This is intracompany business. Subsidiaries owe one another money which reduces transaction costs which arise when many transactions transpire continuously between them.

Transaction costs comprise of commissions on foreign exchange transactions to be paid to foreign exchange dealers and fees paid to the bank for the transfer of funds between subsidiaries.

Process of multilateral netting.

  • Determine the net amount of money owed to subsidiaries
  • By computing these, the number of payments and associated costs can be reduced substantially as indicated in figure 1.
  • Based on net amount owing and receivable settlement can be made directly between subsidiaries
  • Other multilateral companies use a centralized clearing account to which money owed by subsidiaries is paid.

Importance

Clearing transactions happen periodically enhancing the intracompany flow of funds reducing transaction costs significantly

  • Subsidiaries who are owed money have faster access to their funds
  • Parent company identifies subsidiaries with cash surplus which assists in positioning international funds optimally and the cost of the conversion of foreign exchange is minimized as a result of using a central clearing account system.
  • Advantageous to MNEs for managing global cash flows.

Extra information from internet

Multilateral netting arrangements could provide three primary benefits. First, other things being equal, multilateral netting could incrementally reduce credit risk in the system beyond the reduction that could be obtained by bilateral netting. Second, multilateral netting could provide efficiencies by releasing capital currently used to support derivatives transactions and by generating savings in the settlement and risk management processes. Third, multilateral netting may serve to broaden the access to the derivatives market to include weaker credits and smaller participants on a collateralized basis.

Multilateral netting arrangements also have the potential to produce some systemic risks. -First, multilateral netting arrangements have the potential to concentrate risk by funneling transactions through a central counterparty, thereby making the system vulnerable to the central counterparty´s (or central counterparties´ in a risk-sharing arrangement) ability to manage risk and absorb losses. -Second, the existence of a multilateral netting arrangement could actually increase, rather than reduce, credit risk if it induced participants to expand their derivatives activities or if it weakened their incentive for bilateral credit discipline.

Swedish

subsidiary

Austrian

subsidia

Figure 1

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