Barclays 2012 Annual Report Download - page 255

The strategic report Governance Risk review Financial review Financial statements Risk management Shareholder information
15 Derivative financial instruments
Derivative instruments are contracts whose value is derived from one or more underlying financial instruments or indices defined in the contract.
They include swaps, forward rate agreements, futures, options and combinations of these instruments and primarily affect the Group’s net interest
income, net trading income, net fee and commission income and derivative assets and liabilities. Notional amounts of the contracts are not
recorded on the balance sheet. The Group’s objectives and policies on managing the risks that arise in connection with derivatives, including the
policies for hedging, are discussed in the Risk management section on pages 328-329. Trading derivatives are managed within the Group’s market
risk management policies, which are outlined on pages 332-336.
The Group’s exposure to credit risk arising from derivative contracts are outlined in the Credit risk section on page 141.
Accounting for derivatives
The Group applies IAS 39. All derivative instruments are held at fair value through profit or loss, except for derivatives held for risk management
purposes in an effective hedge relationship (see hedge accounting below). This includes terms included in a contract or other financial asset or
liability (the host), which, had it been a standalone contract, would have met the definition of a derivative. These are separated from the host
and accounted for in the same way as a derivative.
Hedge accounting
The Group applies hedge accounting to represent, to the maximum possible extent permitted under accounting standards, the economic
effects of its interest and currency risk management strategies. 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.
Where derivatives are held for risk management purposes, and when transactions meet the required criteria for documentation and hedge
effectiveness, 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.
Fair value hedge accounting
Changes in fair value of derivatives that qualify and are designated as fair value hedges are recorded in the income statement, together
with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. The fair value changes adjust the
carrying value of the hedged asset or liability held at amortised cost.
If hedge relationships no longer meet the criteria for hedge accounting, hedge accounting is discontinued. For fair value hedges of interest
rate risk, the fair value adjustment to the hedged item is amortised to the income statement over the period to maturity of the previously
designated hedge relationship using the effective interest method. If the hedged item is sold or repaid, the unamortised fair value adjustment
is recognised immediately in the income statement.
Cash flow hedge accounting
For qualifying cash flow hedges, the fair value gain or loss associated with the effective portion of the cash flow hedge is recognised initially
in other comprehensive income, and then recycled to the income statement in the periods when the hedged item will affect profit or loss.
Any ineffective portion of the gain or loss on the hedging instrument is recognised in the income statement immediately.
When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss
existing in equity at that time remains in equity and is recognised when the hedged item is ultimately recognised in the income statement.
When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was recognised in equity is immediately
transferred to the income statement.
Hedges of net investments
The Group’s net investments in foreign operations, including monetary items accounted for as part of the net investment, are hedged for
foreign currency risks using both derivatives and foreign currency borrowings. Hedges of net investments are accounted for similarly to cash
flow hedges; the effective portion of the gain or loss on the hedging instrument being recognised directly in other comprehensive income and
the ineffective portion being recognised immediately in the income statement. The cumulative gain or loss recognised in other comprehensive
income is recognised in the income statement on the disposal or partial disposal of the foreign operation, or other reductions in the Group’s
investment in the operation.
Types of derivatives held
Foreign exchange derivatives
The Group’s principal exchange rate-related contracts are forward foreign exchange contracts, currency swaps and currency options.
Forward foreign exchange contracts are agreements to buy or sell a specified quantity of foreign currency, usually on a specified future date
at an agreed rate. A currency swap generally involves the exchange, or notional exchange, of equivalent amounts of two currencies and a
commitment to exchange interest periodically until the principal amounts are re-exchanged on a future date.
Currency options provide the buyer with the right, but not the obligation, either to purchase or sell a fixed amount of a currency at a specified
exchange rate on or before a future date. As compensation for assuming the option risk, the option writer generally receives a premium at the
start of the option period.
Currency derivatives are primarily designated as hedges of the foreign currency risk of net investments in foreign operations.
barclays.com/annualreport Barclays PLC Annual Report 2012 I 253