In general, netting means to allow a positive value and a negative value to cancel each other out. In the context of credit risk, there are at least three specific types of netting:
- Close-out netting: In the event of counterparty bankruptcy, all transactions or all of a given type are netted at market value. The alternative would allow the liquidator to choose which contracts to enforce and which not to (and thus potentially "cherry pick"). There are international jurisdictions where the enforceability of netting in bankruptcy has not been legally tested.
- Netting by novation: The legal obligations of the parties to make required payments under one or more series of related transactions are canceled and a new obligation to make only the net payments is created.
- Settlement or payment netting: For cash settled trades, this can be applied either bilaterally or multilaterally and on related or unrelated transactions.