Barclays 2004 Annual Report Download - page 130

128
The criteria required for a derivative instrument to be classified as a
designated hedge are that:
(i) the transaction must be reasonably expected to match or eliminate
a significant proportion of the risk inherent in the assets, liabilities,
other positions or cash flows being hedged and which results from
potential movements in market rates and credit risk; and
(ii) adequate evidence of the intention to hedge and linkage with the
underlying risk inherent in the assets, liabilities, other positions or cash
flows being hedged, must be established at the outset of the
transaction.
Designated hedges are reviewed for effectiveness by regular tests
to determine that the hedge is closely negatively correlated to the
designated hedged position in each and every identified time band
in the maturity profile.
Profits and losses on interest rate swaps and options entered into
for hedging purposes are measured on an accrual accounting basis,
included in the related category of income and expense and reported
as part of the yield on the hedged transaction. Amounts paid or
received over the life of futures contracts are deferred until the
contract is closed; accumulated deferred amounts on futures contracts
and settlement amounts paid or received on forward contracts are
accounted for as elements of the carrying value of the associated
instrument, affecting the resulting yield.
A premium paid or received in respect of a credit derivative hedging
an asset or liability is amortised over the life of the protection
purchased or sold against either interest payable or interest receivable.
Where a credit event occurs which triggers a recovery under the credit
derivative, then the recovery will be offset against the profit and loss
charge on the underlying asset or liability.
Foreign exchange contracts which qualify as hedges of foreign
currency exposures, including positions relating to investments the
Group makes outside the UK, are retranslated at the closing rate with
any forward premium or discount recognised over the life of the
contract in net interest income.
Profits and losses related to qualifying hedges, including foreign
exchange contracts, of firm commitments and probable anticipated
transactions are deferred and recognised in income or as adjustments
to carrying amounts when the hedged transactions occur.
Hedging transactions that are superseded or cease to be effective are
measured at fair value. Any profit or loss on these transactions,
together with any profit or loss arising on hedging transactions that
are terminated prior to the end of the life of the asset, are deferred
and amortised into interest income or expense over the remaining life
of the item previously being hedged.
When the underlying asset, liability position or cash flow is terminated
prior to the hedging transaction, or an anticipated transaction is no
longer likely to occur, the hedging transaction is measured on the fair
value accounting basis, as described in the section on derivatives used
for trading purposes below, prior to being transferred to the trading
portfolio. The profit or loss arising from the fair value measurement
prior to the transfer to the trading portfolio is included in the category
of income or expense relating to the previously hedged transaction.
Derivatives used for trading purposes
Derivatives entered into as trading transactions, together with any
associated hedging, are measured at fair value and the resultant profits
and losses are included in dealing profits, along with interest and
dividends arising from long and short positions and funding costs
relating to trading activities. Assets and liabilities resulting from gains
or losses on derivative and foreign exchange contracts are reported
gross in other assets or liabilities, reduced by the effects of qualifying
netting agreements with counterparties.
The fair value of derivatives is determined by calculating the expected
cash flows under the terms of each specific contract, discounted back
to a present value. The expected cash flows for each contract are
determined either directly by reference to actual cash flows implicit
in observable market prices or through modelling cash flows using
appropriate financial-markets pricing models.
The effect of discounting expected cash flows back to present value
is achieved by constructing discount curves derived from the market
price of the most appropriate observable interest rate products such
as deposits, interest rate futures and swaps. In addition, the Group
maintains fair value adjustments reflecting the cost of credit risk
(where this is not embedded in the fair value), hedging costs not
captured in pricing models, future administration costs associated with
ongoing operational support of products as well as adjustments to
reflect the cost of exiting illiquid or other significant positions.
(s) Collateral and Netting
The Group enters into master agreements with counterparties
whenever possible and, when appropriate, obtains collateral. Master
agreements provide that, if an event of default occurs, all outstanding
transactions with the counterparty will fall due and all amounts
outstanding will be settled on a net basis.
Where the amounts owed by both the Group and the counterparty
are determinable and in freely convertible currencies, and where the
Group has the ability to insist on net settlement which is assured
beyond doubt, and is based on a legal right under the netting
agreement that would survive the insolvency of the counterparty,
transactions with positive fair values are netted against transactions
with negative fair values.
The Group obtains collateral in respect of customer liabilities where
this is considered appropriate. The collateral normally takes the form
of a lien over the customer’s assets and gives the Group a claim on
these assets for both existing and future liabilities.
The Group also receives collateral in the form of cash or securities in
respect of other credit instruments, such as stock borrowing contracts,
and derivative contracts in order to reduce credit risk. Collateral
received in the form of securities is not recorded on the balance sheet.
Collateral received in the form of cash is recorded on the balance sheet
with a corresponding liability or asset. These items are assigned to
deposits received from bank or other counterparties in the case of
cash collateral received, and to loans and advances to banks or
customers in the case of cash collateral paid away. Any interest
payable or receivable arising is recorded as interest payable or interest
income respectively.
Consolidated accounts Barclays PLC
Accounting policies