What Is Netting in the Context of Derivatives and Counterparty Risk?

Netting is a legal agreement to offset the value of multiple derivative contracts between two or more parties. Instead of exchanging the full value of every contract, only the net difference in value is exchanged.

This process significantly reduces the overall exposure to counterparty risk, as a potential default only exposes the non-defaulting party to the net loss, rather than the gross value of all contracts. It is a critical component of risk management in OTC markets.