Barclays 2005 Annual Report Download - page 77

The Group delivers a fully integrated service to clients for base metals,
precious metals, oil and oil related products, power, natural gas and
other related commodities.
The Group’s commodity business continues to expand, as market
conditions allow, through the addition of new products and markets,
with the 2005 expansion of business being driven both by organic
growth and acquisitions of portfolios.
The Group offers both over the counter (OTC) and exchange traded
derivatives in these commodities. The Group’s base metals business
also enters into outright metal purchases and sale transactions,
while the power and gas business trades both physical forwards and
derivative contracts. The Group continues to develop and offer a range
of commodity related structured products.
The Group’s principal commodity related derivative contracts are
swaps, options, forwards and futures, which are all similar in nature
to such non-commodity related contracts. Commodity derivative
contracts include commodity specification and delivery location as
well as forward date and notional value.
The fair values of commodity physical and derivative positions are
determined through a combination of recognised market observable
prices, exchange prices, and established inter-commodity relationships.
The fair value of OTC commodity derivative contracts is determined
primarily by using valuation models which are based on assumptions
supported by prices from observable market transactions in the same
instrument or are based on available observable market data.
Where a valuation model is used, the fair value is determined based
on the expected cash flows under the terms of each specific contract,
discounted back to present value. The expected cash flows for each
contract are either determined using market parameters such as
commodity price curves, commodity volatilities, commodity
correlations, interest rate yield curves and foreign exchange rates,
or other market prices.
Where possible, fair values generated by models are independently
validated with reference to market price quotes or price sharing with
other institutions. Where all significant model inputs can be validated
to observable market data at the inception of the contract the
valuation of the contract is based on the model value output.
However, where no observable market parameter is available then the
contract is valued at transaction price at inception. Following initial
recognition, the process of calculating fair value from a valuation
model may require estimation of certain pricing parameters,
assumptions or model characteristics. These estimates are calibrated
against industry standards, economic models and observed transaction
prices. The valuation model used for a particular instrument, the
quality and liquidity of market data used for pricing, other fair value
adjustments not specifically captured by the model, market data and
assumptions or estimates in these are all subject to internal review
and approval procedures and consistent application between
accounting periods.
The tables on page 76 analyse the overall fair value of the commodity
derivative contracts by movement over time and source of fair value.
Additionally, the positive fair value of such contracts is analysed by
counterparty credit risk rating.
Risk management
Disclosures about certain trading activities
including non-exchange traded contracts
Barclays PLC
Annual Report 2005 75
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