Barclays 2013 Annual Report Download - page 321

Note 18: Fair value of assets and liabilities continued
FFVA is calculated as the valuation impact of changing from LIBOR-based discounting to using a discount rate that reflects the market cost of
funding. Barclays internal Treasury lending rates are used as an estimate of this rate, although Barclays continues to assess viable alternatives and
evolving market practice. Expected trade cash flows are consolidated at portfolio and currency level. The FFVA impact is applied symmetrically
per currency to positive and negative cash flows.
The discounting period applied takes into account the probability of default of each counterparty, as well as any mandatory break clauses.
Cash flows from partially funded trades (where this could be due to a contractual or non contractual collateral gap) are taken into account.
The FFVA incorporates a scaling factor which is an estimate of the extent to which the cost of funding is incorporated into observed traded levels.
On calibrating the scaling factor, it is with the assumption that Credit Valuation Adjustments (CVAs) and Debit Valuation Adjustments (DVAs) are
retained as valuation components incorporated into such levels. The effect of this scaling factor at 31 December 2013 was £200m (2012:£303m).
Uncollateralised interest rate derivatives traded by the Fixed Income Rates desk are used to determine this scaling factor, as the impact from this
portfolio contributes the majority of the FFVA, where the trading history analysed includes new trades, terminations and novations. The FFVA
balance and movement is driven by the Barclays own cost of funding spread over LIBOR, counterparty default probabilities and recovery rates,
as well as the market value of those derivatives in scope. Movements in the market value of the portfolio in scope for FFVA are driven by interest
rates.
Barclays continues to monitor market practices and activity to ensure the approach to discounting in derivative valuation remains appropriate.
The above approach has been in use since 2012 with no significant changes.
Uncollateralised derivative funding adjustments have reduced by £34m to £67m as a result of reductions in Barclays funding costs and a reduction
in exposure.
Derivative credit and debit valuation adjustments
Credit valuation adjustments (CVAs) and debit valuation adjustments (DVAs) are incorporated into derivative valuations to reflect the impact on
fair value of counterparty credit risk and Barclays own credit quality respectively. These adjustments are modelled for OTC derivatives across all
asset classes. Calculations are derived from estimates of exposure at default, probability of default and recovery rates, on a counterparty basis.
Counterparties include (but are not limited to) corporates, monolines, sovereigns and sovereign agencies, supranationals, and special-purpose
vehicles.
Exposure at default for CVA and DVA is generally based on expected exposure, estimated through the simulation of underlying risk factors. For
some complex products, where this approach is not feasible, simplifying assumptions are made, either through proxying with a more vanilla
structure, or using current or scenario-based mark-to-market as an estimate of future exposure. Where strong collateralisation agreement exists
as a mitigant to counterparty risk, the exposure is set to zero.
Probability of default and recovery rate information is generally sourced from the CDS markets. For counterparties where this information is not
available, or considered unreliable due to the nature of the exposure, alternative approaches are taken based on mapping internal counterparty
ratings onto historical or market-based default and recovery information. In particular, this applies to sovereign related names where the effect
of using the recovery assumptions implied in CDS levels would imply a £105m (2012: £200m) increase in CVA.
Correlation between counterparty credit and underlying derivative risk factors may lead to a systematic bias in the valuation of counterparty credit
risk, termed ‘wrong-way’ or ‘right-way’ risk. This is not incorporated into the CVA calculation, but risk of wrong-way exposure is controlled at the
trade origination stage.
Derivative credit valuation adjustments reduced by £544m to £384m primarily as a result of a reduction in monoline exposure and improvements
in counterparty credit. Derivative debit valuation adjustments have reduced by £132m to £310m primarily as a result of improvements in Barclays
credit.
Portfolio exemptions
The Group uses the portfolio exemption in IFRS 13 Fair Value Measurement to measure the fair value of the group financial assets and financial
liabilities. Assets and liabilities are measured using the price that would be received to sell a net long position (i.e. an asset) for a particular risk
exposure or to transfer a net short position (i.e. a liability) for a particular risk exposure in an orderly transaction between market participants
at the balance sheet date under current market conditions.
Unrecognised gains as a result of the use of valuation models using unobservable inputs
The amount that has yet to be recognised in income that relates to the difference between the transaction price (the fair value at initial
recognition) and the amount that would have arisen had valuation models using unobservable inputs been used on initial recognition, less
amounts subsequently recognised, is as follows:
2013
£m
2012
£m
As at 1 January 148 117
Additions 53 78
Amortisation and releases (64) (47)
As at 31 December 137 148
The reserve held for unrecognised gains is predominantly related to derivative financial instruments.
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