Explain the Concept of “Netting” in the Context of Derivatives Clearing and Settlement

Netting is a process that reduces the number and size of payments or deliveries between counterparties in a financial market. Instead of settling each transaction individually, only the net difference in obligations is exchanged.

In derivatives clearing, netting reduces counterparty risk and operational costs by consolidating multiple trades into a single net obligation, making the settlement process more efficient and reducing the total amount of collateral required to back the trades.