Barclays 2015 Annual Report Download - page 279

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18 Fair value of assets and liabilities
Accounting for financial assets and liabilities – fair values
The Group applies IAS 39. All financial instruments are initially recognised at fair value on the date of initial recognition and, depending on the
classification of the asset or liability, may continue to be held at fair value either through profit or loss or other comprehensive income. The fair
value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.
Wherever possible, fair value is determined by reference to a quoted market price for that instrument. For many of the Group’s financial assets and
liabilities, especially derivatives, quoted prices are not available, and valuation models are used to estimate fair value. The models calculate the
expected cash flows under the terms of each specific contract, and then discount these values back to a present value. These models use as their
basis independently sourced market parameters including, for example, interest rate yield curves, equities and commodities prices, option
volatilities and currency rates.
For financial liabilities measured at fair value, the carrying amount reflects the effect on fair value of changes in own credit spreads derived from
observable market data, such as spreads on Barclays issued bonds or credit default swaps (CDS). Most market parameters are either directly
observable or are implied from instrument prices. The model may perform numerical procedures in the pricing such as interpolation when input
values do not directly correspond to the most actively traded market trade parameters.
On initial recognition, it is presumed that the transaction price is the fair value unless there is observable information available in an active market
to the contrary. The best evidence of an instrument’s fair value on initial recognition is typically the transaction price. However, if fair value can be
evidenced by comparison with other observable current market transactions in the same instrument, or is based on a valuation technique whose
inputs include only data from observable markets, then the instrument should be recognised at the fair value derived from such observable
market data.
For valuations that have made use of unobservable inputs, the difference between the model valuation and the initial transaction price (‘Day One
profit’) is recognised in profit or loss either: on a straight-line basis over the term of the transaction; or over the period until all model inputs will
become observable where appropriate; or released in full when previously unobservable inputs become observable.
Various factors influence the availability of observable inputs and these may vary from product to product and change over time. Factors include
the depth of activity in the relevant market, the type of product, whether the product is new and not widely traded in the marketplace, the
maturity of market modelling and the nature of the transaction (bespoke or generic). To the extent that valuation is based on models or inputs
that are not observable in the market, the determination of fair value can be more subjective, dependent on the significance of the unobservable
input to the overall valuation. Unobservable inputs are determined based on the best information available, for example by reference to similar
assets, similar maturities or other analytical techniques.
The sensitivity of valuations used in the financial statements to possible changes in significant unobservable inputs is shown on page 286.
Critical accounting estimates and judgements
The valuation of financial instruments often involves a significant degree of judgement and complexity, in particular where valuation models make
use of unobservable inputs (‘Level 3’ assets and liabilities). This note provides information on these instruments, including the related unrealised
gains and losses recognised in the period, a description of significant valuation techniques and unobservable inputs, and a sensitivity analysis.
Valuation
IFRS 13 Fair Value Measurement requires an entity to classify its assets and liabilities according to a hierarchy that reflects the observability of
significant market inputs. The three levels of the fair value hierarchy are defined below.
Quoted market prices – Level 1
Assets and liabilities are classified as Level 1 if their value is observable in an active market. Such instruments are valued by reference to unadjusted
quoted prices for identical assets or liabilities in active markets where the quoted price is readily available, and the price represents actual and
regularly occurring market transactions. An active market is one in which transactions occur with sufficient volume and frequency to provide pricing
information on an ongoing basis.
Valuation technique using observable inputs – Level 2
Assets and liabilities classified as Level 2 have been valued using models whose inputs are observable in an active market. Valuations based on
observable inputs include assets and liabilities such as swaps and forwards which are valued using market standard pricing techniques, and options
that are commonly traded in markets where all the inputs to the market standard pricing models are observable.
Valuation technique using significant unobservable inputs – Level 3
Assets and liabilities are classified as Level 3 if their valuation incorporates significant inputs that are not based on observable market data
(unobservable inputs). A valuation input is considered observable if it can be directly observed from transactions in an active market, or if there is
compelling external evidence demonstrating an executable exit price. Unobservable input levels are generally determined via reference to observable
inputs, historical observations or using other analytical techniques.
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