Barclays 2005 Annual Report Download - page 142

Consolidated accounts Barclays PLC
Accounting policies
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. These items are assigned to deposits
received from bank or other counterparties. Any interest payable or
receivable arising is recorded as interest payable or interest income
respectively except for funding costs relating to trading activities which
are recorded in net trading income.
Netting
From 1st January 2005
Financial assets and liabilities are offset and the net amount reported
in the balance sheet if, and only if, there is a legally enforceable right to
set off the recognised amounts and there is an intention to settle on a
net basis, or to realise an asset and settle the liability simultaneously.
In many cases, even though master netting agreements are in place,
the lack of an intention to settle on a net basis results in the related
assets and liabilities being presented gross in the balance sheet.
Prior to 1st January 2005
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 carrying values are netted against transactions with negative
carrying values.
15. Derivatives and hedge accounting
Derivatives are used to hedge interest rate, exchange rate, commodity,
and equity exposures and exposures to certain indices such as house
price indices and retail price indices related to non-trading positions.
In addition, the use of derivatives and their sale to customers as risk
management products is an integral part of the Group’s trading
activities. Derivatives entered into for hedging purposes and for trading
purposes include foreign exchange, interest rate, credit, equity and
commodity derivatives mainly in the form of swaps, forwards, options
and combinations of these instrument types.
Derivatives
From 1st January 2005
Derivatives are measured initially at fair value and subsequently
remeasured to fair value. Fair values are obtained from quoted prices
prevailing in active markets, including recent market transactions, and
valuation techniques, including discounted cash flow models and
option pricing models as appropriate. All derivatives are included in
assets when their fair value is positive, and liabilities when their fair
value is negative, unless there is the legal ability and intention to settle
net (as per accounting policy 14).
Prior to 1st January 2005
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 net trading income, 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 and 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. The calculation of fair value
for any financial instrument may also require adjustment of the quoted
price or model value to reflect the cost of credit risk (where not
embedded in underlying models or prices used), or to reflect hedging
costs not captured in pricing models (to the extent they would be
taken into account by a market participant in determining a price).
Embedded derivatives
From 1st January 2005
Some hybrid contracts contain both a derivative and a non-derivative
component. In such cases, the derivative component is termed an
embedded derivative. Where the economic characteristics and risks of
the embedded derivatives are not closely related to those of the host
contract, and the host contract itself is not carried at fair value through
income, the embedded derivative is bifurcated and reported at fair
value with gains and losses being recognised in the income statement.
Profits or losses cannot be recognised on the initial recognition
of embedded derivatives unless the host contract is also carried at
fair value.
Hedge accounting
From 1st January 2005
Where derivatives are held for risk management purposes, and when
transactions meet the criteria specified in IAS 39, the Group applies
fair value hedge accounting, cash flow hedge accounting, or hedging
of a net investment in a foreign operation as appropriate to the risks
being hedged.
When a financial instrument is designated as a hedge, the Group
formally documents the relationship between the hedging instrument
and hedged item as well as its risk management objectives and its
strategy for undertaking the various hedging transactions. The Group
also documents its assessment, both at hedge inception and on an
ongoing basis, of whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values
or cash flows of hedged items.
The Group discontinues hedge accounting when:
(i) it is determined that a derivative is not, or has ceased to be, highly
effective as a hedge;
(ii) the derivative expires, or is sold, terminated, or exercised;
(iii) the hedged item matures or is sold or repaid; or
(iv) a forecast transaction is no longer deemed highly probable.
In certain circumstances, the Group may decide to cease hedge
accounting even though the hedge relationship continues to be
highly effective by no longer designating the financial instrument
as a hedging instrument.
Barclays PLC
Annual Report 2005
140