Matching and Netting Agreements

Netting and matching are a feature of foreign exchange risk management and are carried out to reduce the scale of external hedging required.

For example, Group X is expecting to receive $10 million in one subsidiary and pay $6 million at the same time in another subsidiary. Clearly the group only has a net exposure of a receipt of $4 million.

The terms 'netting' and 'matching' are often used interchangeably but strictly speaking they are different:

• Netting refers to netting off group receipts and payments, as in the example above.
• Matching extends this concept to include third parties such as external suppliers and customers.

Normally netting/matching only occurs in one currency at a time - in the above example $ were matched against $. However, if an agreement exists to do so, groups can also match different currencies against each other. This is the topic of this page.

Calculations

The calculations can be presented in one of two ways: the tabular method and the diagrammatical method. Both are explained below.

Tabular method

Step 1: Set up a table with the name of each company down the side and across the top.

Step 2: Input all the amounts owing from one company to another into the table and convert them into a common (base) currency (at spot rate).

Step 3: By adding across and down the table, identify the total amount payable and the total amount receivable by each company.

Step 4: Compute the net payable or receivable, and convert back into the original currency.

Diagrammatical method

Step 1: Convert all currency flows to a common (base) currency using spot rates (NOT forward or future rates).

Step 2: Clear the overlap of any bi-lateral indebtedness.

E.g.

Step 3: Clear the smallest leg of any 3 way circuits.

E.g.

Step 4: Clear the smallest leg of any 4 way circuits (then 5, etc).

E.g.

Step 5: Convert back into original currencies.

Step 6: Use the simplified figures for:

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Tags:	netting;matching;foreign exchange risk