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Close-out netting is a technique used to determine the net obligations of a defaulted counterparty to a derivatives transaction. The counterparty’s remaining contractual obligations are terminated, and the final positive and negative replacement values of its positions are combined into a single net payable or receivable. A number of countries have carve-outs from their bankruptcy laws to allow for close-out netting. Without them, insolvency administrators could immediately trigger contracts where the defaulted party is owed money but would require counterparties with opposite contracts to get in line with other creditors, which may take years and result in a smaller payout.
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