Barclays 2014 Annual Report Download - page 295

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18 Fair value of financial instruments continued
Uncollateralised derivative trading activity is used to determine this scaling factor. The trading history analysed includes new trades, terminations,
trade restructures 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 the underlying derivatives. Movements in the market value of the portfolio in
scope for FFVA are mainly driven by interest rates, inflation rates and foreign exchange levels.
Barclays continues to monitor market practices and activity to ensure the approach to uncollateralised derivative valuation remains appropriate.
The above approach has been in use since 2012 with no significant changes.
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 £120m (2013: £105m) 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 increased by £34m to £418m primarily due to an increase in exposure as a result of lower interest rates,
partially offset by a reduction in monoline exposure. Derivative debit valuation adjustments have reduced by £133m to £177m 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 groups of financial assets and liabilities.
Instruments 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. Accordingly, the Group measures the fair value of the group of financial assets and liabilities consistently
with how market participants would price the net risk exposure at the measurement date.
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 £96m (2013: £137m). There are no additions (2013: £53m) and £41m (2013: £64m) of amortisation and
releases.
The reserve held for unrecognised gains is predominantly related to derivative financial instruments.
Third party credit enhancements
Structured and brokered certificates of deposit issued by Barclays Group are insured up to $250,000 per depositor, by the Federal Deposit
Insurance Corporation (FDIC) in the United States. The FDIC is funded by premiums that Barclays and other banks pay for deposit insurance
coverage. The carrying value of these issued certificates of deposit that are designated under the IAS 39 fair value option includes this third party
credit enhancement. The on balance sheet value of these brokered certificates of deposit amounted to £3,650m (2013: £3,136m).
Valuation control framework
The valuation control framework covers fair value positions and is a key control in ensuring the material accuracy of valuations.
The valuation control function within Finance is responsible for independent price verification, oversight of prudent and fair value adjustments and
escalation of valuation issues.
Governance over the valuation process is the responsibility of the Valuation Committee, and this is the governance forum to which valuation
issues are escalated.
The Valuation Committee meets on a monthly basis and is responsible for overseeing valuation policy and practice within the Group. It provides
reports to the Board Audit Committee, which examines the judgements taken on valuation and related disclosures.
Price verification uses independently sourced data that is deemed most representative of the market. The characteristics against which the data
source is assessed are independence, reliability, consistency with other sources and evidence that the data represents an executable price. The
most current data available at balance sheet date is used. Where significant variances are noted in the independent price verification process, an
adjustment is made to fair value. Additional fair value adjustments may be made to reflect such factors as bid-offer spreads, market data
uncertainty, model limitations and counterparty risk – further detail on these fair value adjustments is disclosed on page 292.
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